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Europe Wants To Avoid Downgrading

German industry is in crisis, with economic activity at a standstill. The financial outlook for the euro area is uncertain. Reports conclude that Europe faces numerous challenges that require time and effort.

By EC Invest

German industry is sinking into the crisis, and all economic activity is at a standstill. The financial outlook for the euro area is mixed. Reports follow one another, and they all come to the same conclusion: Europe suffers from many ills. Correcting them will take time and effort.

An industry in distress

The industrial sector and Germany are undoubtedly the best examples of the economic difficulties in the euro area. European industry has been in crisis for several years. The situation is particularly worrying in Germany, where industrial production has fallen by more than 5% over the last twelve months. The end of cheap Russian oil hit hard the European industry, which was faced overnight with electricity and gas prices several times higher than in the US.

Rising protectionism around the globe has also slowed exports and production in the old continent. Massive US government support has also led some companies to focus on the US rather than euro area production sites.

Heavily subsidised, Chinese products have invaded international markets and are increasingly competing with European production. Add to this the labour shortages, administrative burdens, and inadequate infrastructures, and you have an indigestible cocktail for European industry.

Competitiveness to be restored

The euro area is penalised by its lack of competitiveness.

As the recent report by Mario Draghi, the former President of the European Central Bank, once again points out, this is not a new observation. This is due to the slow growth of European productivity, almost half as fast as in the US over the last 20 years, because of a lower diffusion of new technologies.

Europe must catch up on the digital revolution, whether creating new businesses or using new economic technologies. This is due to a static industrial structure.

The top three US companies in research and innovation were active in automotive and pharmaceutical in the 2000s, software and hardware in the 2010s, and finally, in the digital world since the 2020s. In Europe, they are systematically automotive companies. While Europe invested mainly in old industries with low productivity gains, the US focused on booming new sectors. And so, only 4 of the 50 largest global technology companies are European.

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Insurmountable constraints?

Europe’s downgrading is not inevitable, according to the Draghi report. To remedy this, it would first be necessary to truly achieve the union of capital so that the savings of Europeans finance the young, innovative companies of the old continent rather than seeing them exiled to the United States to access the necessary financial resources. Completing the single market will also facilitate the emergence of a globally competitive European champion. Last but not least, massive investment will be required. This requires coordinated and financed policies at the European level. Unfortunately, this is far from being the case.

Today, most of the expenditure to support the industrial sector and innovation in Europe is made nationally. This wastes money when the same project is duplicated in several countries. This also causes tensions between European partners who try to have a more significant share of the cake. However, moving from this national logic to a common European approach is practically impossible because of the significant budgetary differences between the European partners. Low-debt countries like the Netherlands, where public debt was limited to 46.5% of GDP at the end of 2023, do not want to finance countries deemed lax, such as Italy, which has accumulated a mountain of debt (137.3%).

Low prospects

The decline in industrial production and investment by enterprises outside our borders directly penalises economic activity. However, the industrial crisis also indirectly slowed down growth in the euro area. The disappointments of the large European industrialists are worrying the workers.

Despite an unemployment rate at a historic low, household consumption is in the doldrums. Europeans are focusing on saving today at a historic high outside the years of COVID-19 when consumption was limited due to health restrictions and shortages. As a result, economic dynamism is weak in the euro area, with GDP growing by only 0.6% over the last twelve months.

Growth will remain weak in the medium term. European industry will continue to be penalised by the higher energy prices and the large public subsidies given to its US and Chinese competitors. Suspended for the last few years due to COVID-19, the stability pact will also be applied again. Even in its new, more flexible version, it will require significant fiscal efforts for countries whose debt has exploded in recent years. In the long term, with an ageing population that will reduce the number of workers, the euro area economy could stagnate without opening borders to immigration or if productivity does not generate significant gains.

Eurozone: Inflation At Its Lowest Since 2021

The fall in oil prices allowed a sharp drop in inflation in August. This was due to a reduction in the ECB’s key interest rates announced on 12 September.

In August, inflation in the euro area fell sharply to 2.2%, down from 2.6% in July. Energy prices fell 3.0% compared to August 2023. After being slightly up for several months, they suddenly turned down. Such a trend change was not apparent at a time when the conflict in the Middle East continues to be of concern.

However, the world economy’s collapse has weighed on energy demand and, thus, on prices. This news is less suitable for services prices, which are rebounding this summer with a 4.2% year-on-year increase. Services are currently the primary source of inflation in Europe.

These weak economic prospects do not make for the euro area stock markets. While some European companies are attractive individually, we do not buy euro-area equities as part of our portfolio strategy.

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