With steepling debt, low growth and more headwinds on the way, has Europe entered an economic ‘doom-loop’? Spear’s scrambles reporters across the continent to find out
Cast your mind back to 1980. Reagan beats Carter and Mrs Thatcher’s not for turning, while Blondie, Bowie and Lennon top the charts. The global economy looks different, too. The GDPs of the US and what we now recognise as the eurozone are level-pegging at roughly $3 trillion each.
Then something happened. Europe fell behind. ‘The eurozone missed, at a macro-economic level, three investment cycles,’ explains Christophe Donay, head of asset allocation and macroeconomic research at Swiss wealth manager Pictet. In the Nineties, the 2000s and the 2010s, the American economy made great leaps forward, riding waves of technology-powered growth. From the dotcom boom to the sustained success of Apple and Amazon, the US has been leading the way. ‘Where is Motorola or Ericsson now?’ French-born Donay asks. ‘These companies are dead. Where is the European Google?’
Google office on, Barrow Street, Dublin. Photo credit: Ian Paterson
Today the US economy stands at $22 trillion. The eurozone’s, however, trails at about $13 trillion.
When Donay sits down with Spear’s at Pictet’s London office, a stone’s throw from the Ritz, he explains that Europeans already have 70 per cent less disposable income per capita than their American cousins. European growth trails behind too, trending at about half of the States’ respectable2-3 per cent. What’s more, European unemployment is higher at 7.5 per cent, compared to 3.6 per cent in the US.
‘As a consequence, in Europe, we have rising populism,’says Donay glumly. People are ‘afraid of inequality’ and the future for their children looks grim. In his view, the likely outcome is that populist government policy will stymie European growth further. And that’s without considering the impact of their debts. ‘All these trends are fully integrated: economic trends, asset class trends.’ Unsurprisingly he advises clients in Europe to ‘diversify geographically into US dollar assets.’
The ultimate result could well be a vicious cycle of economic decline: a doom-loop, if you will. ‘Europe is deteriorating and going to a potential break-up,’ Donay predicts.‘We are not in the break-up yet, but it’s just a matter of time.
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A short hop away on the Eurostar, Spear’s arrives in Paris to test Donay’s grim thesis. Here they are hoping to build anew generation of technology-driven businesses at the world’s biggest ‘start-up campus’, Station F. Backed by French telecoms billionaire Xavier Niel, this converted34,000-square-metre former freight depot in the sleepy 13th arrondissement is something to behold.
On arrival, Spear’s is greeted by a hologram and then led(by a human being) through the building, past start-up types floating around on electric scooters, and into a vast hall populated with artworks by Jeff Koons and Ai Weiwei. There are hubs and incubators bearing familiar names such as Facebook and LVMH, which has its own luxury tech accelerator, ‘La Maison des Start-ups’.
It’s immediately clear that Station F is serious about its ambitions. The international cast of 1,000 start-ups have easy access to more than 40 venture capital firms, and in excess of 30 public services to assist with matters such as visas, tax and trade.
President Macron said in 2017 that he wanted France to be ‘a start-up nation’ and has visited the campus on several occasions. In May his government completely overhauled the country’s ‘tech visa’ to attract international talent.
The Gilets Jaunes protest. Photo credit Olivier Ortelpa @WikimediaCommons
At present, the French economy is ticking along, with growth at a modest but steady 1.2-1.4 per cent. Unemployment is set to drop to 8.5 per cent at the end of 2020. But the country still has problems. Even though the Champs-Elysées is peaceful today, the darkest days of the gilets jaunes protests are fresh in the memory and still pose questions for a president who wants to overhaul the public sector, unemployment insurance, welfare and the pension system.‘All of these projects make sense,’ says Christoph Frei, a professor of political science at the University of St Gallen, Switzerland. ‘Implementation, however, is far from certain.The gilets jaunes protests have shown that public policy cannot simply be decreed from above.
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If it’s uncertainty you seek, then Italy, too, has it in spades.National debt in Europe’s reigning economic basket case is now 133 per cent of GDP – more than double the 60 percent that’s supposed to be the maximum level under Europe’s economic ‘growth and stability pact’.
However, when the British hotelier Sir Rocco Forte sits down with Spear’s at his London offices, he seems unfazed.Forte has recently been pouring money into his father’s native Italy, with the opening of two hotels this year. New establishments in Puglia and Rome (his second in the capital) bring his total tally of hotels in Italy to five.
Photo credit: David Harrison
He assures Spear’s that he would never have invested in Italy were it not for the fact that the luxury hotel business is so insulated from the country’s wider economic problems. He can, however, attest to the difficulty of doing business there. ‘For prospective employers it’s very hard to take people on,’ the Brexiteer says, referring to Italy’s labour laws that make it extremely difficult – if not impossible, in his view – to dismiss workers once they are on the payroll.
While productivity has been stagnating across Europe, Italy’s has been in reverse gear. Between 1997 and 2019 this averaged minus 0.1 per cent, and Italy is the only Western economy where income per person is lower in real termsthan in 2000. According to Jack Allen, an analyst at Capital Economics, the country is in a period of ‘perma-recession’.
Sir Rocco is unequivocal: ‘Italy’s debt was over 100 percent of GDP when they joined Europe. They should neverhave been allowed to join. On top of this, single currenciesnever survive when there hasn’t been a system of centralisedtaxation.’ The euro, he adds, was created for ‘political’ ratherthan ‘economic’ reasons.
‘It hasn’t worked.’ Does he think Italy is doomed? ‘Doomed?’ he repeats, before settling back into his chair and taking a long slurp oftea. ‘Doomed is the wrong word, but we will continue to fall behind the rest of the world.’
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Economically speaking, things look brighter in Hungary, which joined in the EU 2004. GDP growth stood at animpressive 5.3 per cent year-on-year for the first quarter of2019. Unemployment is just 3.6 per cent. It’s in part thanks to Viktor Orbán, the country’s controversial ‘strongman’ prime minister, who took office in 2010 amid a climate of mounting debt and high unemployment.
Photo credit: Jorge Franganillo @Flickr
So-called ‘Orbanomics’ saw private pension funds nationalised to raise money and help pay off public debt, income tax cut to a flat rate of 15 per cent, VAT increased to 27 percent, and special rates applied to the revenues of foreign-owned firms. Corporation tax stands at just 9 per cent. ‘That helped business attract talent and also helped private consumption,’ says Eglé Fredriksson, a portfolio adviser at East Capital. ‘The fiscal measures were positive for realestate and consumption.’
FDI inflows rose to €6.4 billion last year. Public debt, which hit a record 80.7 per cent in 2011, is due to fall to 65 per cent by 2020. The economy is expected to grow at 3 percent next year. Yet Orbán has drawn sharp criticism, not least for his anti-immigration stance and boast that Hungary is an ‘illiberal democracy’. For now, his ruling Fidesz party seems like a curious thing – a hard-right, pro-EUparty. But as Hungary is the fourth biggest net beneficiary of the EU, perhaps we shouldn’t be surprised.
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The fifth biggest net recipient of EU funds is Portugal, where, in the wake of the 2008 financial crisis, national debt almost doubled to 96.2 per cent of the country’s GDP. However, today, as light shimmers off the surface of the River Tagus through the floor-to-ceiling windows of the dean of the Lisbon School of Economics’ office, Professor Clara Raposo explains things are looking rosier.
The economy has recovered from its darkest days–thanks, in part, to Lisbon’s thriving tech sector. The countryis even expecting the first budget surplus in 45 years in 2020. ‘It’s very small,’ concedes Raposo, ‘but it’s for the firsttime since… maybe for ever.’ During the 2008 crisis ‘there was a lack of opportunity, which made the Portuguese reinvent themselves’, she explains. ‘Either you created something new or you were lost.’
Now her city thrums with start-ups and an international cast of freelancers and workers attracted by the lifestyle and low cost of living (45 per cent less than London’s, according to one global index). Web Summit, the largest technology conference in the world, agreed to hold its next ten editions in the city, bringing up to 100,000 representatives from the likes of Facebook, Amazon and Microsoft each time.
Lisbon has attracted Google, Mercedes-Benz and Volkswagen, which have all opened innovation or research centres in the past couple of years. There are local success stories, too: Aptoide, created by Paulo Trezentos, has been named one of the city’s hottest start-ups and is building an alternative to Google Play, generating headlines around the world. Raposo hopes more are on their way, and points to the government’s Startup Lisbon initiative, which is transforming a former army factory complex into a mega-campus for start-ups, the Hub Criativo do Beato.
But what of the country as a whole? ‘Traditional industries have restructured themselves a lot,’ says Raposo. ‘They’ve started exporting a lot more.’ She points to the auto parts industry, as well as its €2 billion shoe industry, shining thanks to the popularity of the ‘Made in Portugal’ label.
One challenge is the country’s brain drain. The next generation seems more determined than ever, says Raposo, to move away. But she is hopeful. ‘If someone really wants to come here, invest and find good, talented people with qualifications, pay them a little bit more than what we are currently paying – it will be hugely attractive,’ she predicts.
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Frankfurt was always supposed to be one of the biggest beneficiaries of Brexit. And, as Spear’s surveys the neighbouring skyscrapers from one 33rd-storey window in the German financial hub, the signs are promising.
‘In Frankfurt, we’ve seen a 15 per cent rise year-on-year in the number of professionals in financial services,’ says Nick Dunnett of specialist recruiter Robert Walters, whose office occupies this elevated position in the 656ft Main Tower. ‘Frankfurt will keep growing,’ he adds. ‘No doubt about it.’
Frankfurt cityscape. Photo credit: 12019/10262 @Pixabay
Among the many skyscrapers is the home of the European Central Bank. Outgoing governor Mario Draghi has been criticised by Donald Trump, who threatened a trade war over what he interpreted as Europe’s ‘devaluation’ of the euro. In some quarters, faith in the ECB has faded following its failure to hit its inflation target of 2 per cent. Economists who spoke to Spear’s noted how the lack of fiscal union in Europe meant monetary policy and tax policy cannot be orchestrated, limiting its effectiveness.
At his office on the campus of Goethe University in the city, Professor Jan Pieter Krahnen, director of think-tank Sustainable Architecture for Finance in Europe (SAFE), tells Spear’s there is cause for optimism. He has recently returned from a trip to the US, where he visited a ‘smart factory’ in Chicago run by the German company Trumpf. It is, he explains, designed to offer a glimpse of manufacturing facilities in a world shaped even more by technologies such as artificial intelligence and big data.
‘They say in the US there is nothing even remotely comparable to what we are doing,’ he says. ‘As long as [the world] needs industrial facilities, Germany will be strong and can thrive – but that’s only part of the story. Can the car industry in Germany survive the way that it is? Probably not. But it can survive in a different way.’
However, confronted with Donay’s thesis of Europe’s decline, Krahnen speaks plainly. ‘I see a lot of headwinds coming, and already here,’ he says, noting a Trump administration ‘strategy’ to ‘break the euro apart’, as well as internal problems. ‘Europe is very weak. It’s not united. It does not have a well integrated internal market. Overall, it has a feeble investment policy and that makes it very vulnerable.’
Citing ‘increasing political extremism’ at both ends of the ideological spectrum, Krahnen adds: ‘I think the prospect is really very gloomy for Europe for the next 10 or 15 years. You might say that the UK’s strategy is correct; everybody should go on their own. But we would simply be wiped away by the global powers that are emerging. So, if we do not get our act together, we will have a very tough time. But I am also optimistic that we will.’ That then, may be the $20 trillion question: How does Europe, in Krahnen’s words, ‘get its act together’? It won’t be easy, he says, but the answer probably lies in further democratisation of the EU.
‘To have a clear migration of democratically legitimised power from the nation state to a European government,’ says Krahnen, ‘is the only path.’
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But even if this can be achieved, the continent will still face a mighty challenge: demographics.
Forecasts put the EU27 population at 439 million in2070 – down from 445 million today. But the population isn’t just shrinking; it’s ageing, too. Currently, 19.5 per cent of Europeans are over the age of 65. By 2070, that figure is expected to be 29.2 per cent. Factor in the young, and that’s barely one worker for every dependent child or pensioner.
Europe’s expected demographic shift may not be spoken about very often, says economist Francesco Papadia of the Brussels think-tank Bruegel. ‘But, over the long term, it is the most important factor. Of all the projections you can make about the future, these are the least uncertain.’
Could Europe replicate the kind of stagnation that has defined the recent economic history of Japan, where an ageing population has created a ‘lost generation’? ‘There is one difference, which is a double-edged sword,’ says Papadia, who has held positions at the ECB and the Italian central bank. ‘In Japan there is hardly any immigration. In Europe there are immigrants. The problem is that we don’t seem to be very good at managing it.’
So, all is not lost. But if Europe is to grab this economic lifeline, rather than make a noose for its own neck, then it will have to act quickly. Time is running out.
Photo credit: Leica V-Lux 1 @MaxPixel
This article first appeared in the Sept/Oct issue of Spear’s. For all this and more, subscribe here.