The Long-Term Economic Decline of Europe

Much has been written about the economic decline of Japan over the past three decades. In 1991, Japan was one of the most successful economies in the world, generating higher rates of growth than nearly all other economies and achieving a level of wealth that was above that of all other large economies, including the United States.

However, since the bursting of Japan’s asset bubble in 1992, the Japanese economy has become better-known for stagnation and the constant threat of deflation. Fortunately for the global economy, while the Japanese economy has generated very little growth over the past three decades, other economies, most notably China and other Asian emerging markets, have stepped up to more than offset Japan’s lost contribution to global economic growth.

While Japan’s decline has not had a major impact on the global economy in recent decades, there is another threat looming that, while mirroring the problems that beset Japan in the 1990s, has the potential to cause significantly more harm to the global economy, the stagnation of the European economy. In 1991, Japan accounted for a little more than 13% of total global GDP, as it was, by that time, the world’s second-largest economy.

In contrast, while Europe’s share of global GDP has been declining steadily since the Second World War, it still accounts for 21% of total global GDP, a sizeable share. Furthermore, Europe’s remains a relatively wealthy region, with per capita GDP levels that trail only North America on a regional basis. Therefore, should the European economy fall into a period of long-term Japan-like stagnation, the impact on the global economy would be far greater, particularly as there are fewer economies today with the potential to offset the lack of growth in Europe. The problem is, it appears that Europe, or at least many sizeable parts of the region, have already done so.

A Disappointing 21st Century

The first signs of a general European slowdown emerged in the early 2000s, which was, oddly enough, a period of great optimism in Europe. This period marked the high-water mark of European integration, with the unification of the continent in the European Union and NATO, and the launch of the region’s common currency, the euro. At the same time, Europe was proclaiming to the world its intention of becoming the world’s most technologically advanced economy and there were even calls for a common European defense force to take its place besides NATO. However, the results have been far less than what was promised, particularly on the economic side.

Sure, some economies in Europe have performed a little better than others when taking this 20-year view, but the fact is that Europe under-performed nearly all other major economies during this period, despite all of the integration that took place across the region. When taking this longer-term view, we can see that some European economies, such as the United Kingdom and Spain, have managed to record growth rates that are not too far behind those of the leading non-European developed economies. However, most European economies have recorded growth rates of less than 1% per year (when this year’s growth forecasts are taken into account) over a period of 20 years. That is exactly the type of result that has had Japan labelled as a stagnating economy since the 1990s.

No Growth Since 2009

If we take a shorter-term view (in this case the 12 years since the Global Financial Crisis), Europe’s economic results look even worse. Of course, the financial crisis did not originate in Europe, but no region suffered a deeper or longer downturn as a result of this crisis than Europe. In fact, over the past 12 years, the European economy has bounced from crisis-to-crisis, including the Financial Crisis, a series of Euro crises, Brexit and now the coronavirus pandemic. In fact, while many key economies around the world have suffered as a result of these crises, few have suffered as badly as Europe.

By the time 2020 is over, Europe’s economic output is forecast to be smaller than it was in 2008. Some economies, most notably Greece, Italy and Spain, will have seen economic output fall sharply during this period, while others, including Germany and France, will have recorded very little growth at all. This means that this has been a lost decade, if not a lost two decades, for what is one of the world’s leading economic centers.

Europe’s Laggards

It can be argued that a number of European economies are already in a period of long-term stagnation. Worse, it appears that these struggling economies will continue to find it difficult to generate much economic growth in the years ahead. These stragglers include:

• France, the region’s third-largest economy, has generated almost no growth since the Financial Crisis, and while governments there have tried to enact reforms in recent years, France has continued to lose ground in terms of economic competitiveness.
• Italy, the region’s fourth-largest economy, has seen its economy shrink by an average of more than 1% per year since 2008, the worst performance of any large economy in the world. Worse, it is difficult to see how a country in Italy’s position will be able to generate any growth in the coming years.
• Spain, in contrast, had been generating significant growth in the early part of this century, but since the Financial Crisis, its economy has also declined. In fact, Spain has become one of Europe’s most volatile economies, although there is still some hope that it can generate some growth in the coming years.
• Finally, Greece has been Europe’s worst-performing economy over the past 12 years, with the Greek economy shrinking by an average of nearly 3% per year during that period. As Greece has done little to boost its competitiveness, growth will remain hard to come by in the years ahead.

Each of these countries have a number of factors in common, including rapidly-declining working-age populations, a lack of high-tech and high-growth industries and an overall loss of competitiveness vis-à-vis their rivals in Europe and further abroad. Together, these four countries have a combined population of 185 million people and a combined GDP of $6.3 billion, which means that their poor economic performance during this period has been a drag on the wider global economy.

Europe’s More Successful Economies

While the European economy as a whole has struggled mightily to overcome the series of crises that it has faced in recent years, there have been some European economies that have managed to generate growth during this period. These include:

• The United Kingdom, the region’s second-largest economy, had, until Brexit at least, been the leading driver of economic growth in Europe this century. This was due to its strong financial sector and London’s ability to attract investment from outside of Europe. Unfortunately, the coronavirus pandemic and Brexit have brought this growth to a halt, and have led to an uncertain future for the British economy.
• Germany, while not performing nearly as well as some analysts claim, has at least managed to generate some growth during this period, thanks largely to its ability to export outside of Europe. However, Germany faces an uncertain future due to its worsening demographic situation and increasing foreign competition within key sectors of the German economy.
• Finally, some of the region’s more competitive economies, including Sweden, Switzerland and some Central European economies, have also managed to generate some growth since the Financial Crisis. Whether or not they can return to growth after the pandemic remains to be seen, but thanks to their sensible economic policies, they are in a better position than most of their neighbors.

For those European economies that have managed to record some growth in recent years, there are some commonalities. One is that the countries that have generated growth have largely enacted economic policies aimed at boosting their ability to generate export growth (such as Germany and Sweden) or to attract foreign investment (such as the UK or Switzerland). Another factor is that these economies have been able to avoid becoming dependent upon their domestic markets, or just European markets, to export their goods and services or to attract investment. Unfortunately, too many European countries have not been able to emulate these economies’ relative success, to the detriment of the European economy as a whole.

The Factors Behind Europe’s Stagnation

So why has Europe struggled so badly to generate growth this century? There are many factors that have contributed to this poor economic performance.

• Like Japan, Europe is facing a serious demographic decline in which the working-age populations of its leading economies have stagnated or are already in decline. This has reduced Europe’s domestic market growth potential, while leading to labor shortages (at least until the pandemic arrived) in many key economies, including Germany and the United Kingdom. At the same time, an increasing share of Europe’s population is retired, and given the region’s generous retirement benefits, this is becoming a major drag on public finances in Europe.
• Another key factor is Europe’s increasing dependence upon exports to generate economic growth. As Europe’s domestic market weakens, it can only generate higher levels of growth by increasing its export revenues. However, this leaves Europe exposed to the threat of external shocks, as we have witnessed in recent years, and to foreign competition for these export markets.
• While Europe’s export dependency is increasing, its economic competitiveness has been declining. Not only are cost levels prohibitively high in many European countries, but the region’s weakening domestic market makes the region less attractive to potential investors.
• At the same time, Europe has fallen far behind the United States, China and others in many of the world’s fastest-growing high-tech industries, limiting Europe’s growth potential. Add to this the fact that Europe has struggled to generate new businesses and one can see that Europe will continue to struggle to gain a foothold in the industries of the future without major regulatory and cultural changes.

These factors will be hard to overcome and they pose an immense challenge to Europe’s economic future. It is clear that, if most European countries continue to ignore these challenges, the region’s stagnation that has lasted for most than a decade will certainly continue.

A Threat to the Global Economy

The Japanese experience since the early 1990s have shown the world how hard it is to pull out of an economic slump that is driven by the factors that we have mentioned. Unfortunately for Europe, these same factors are now in place in Europe and have been contributing to the region’s dreadful economic performance since the Financial Crisis. Europe’s demographic situation will only grow worse in the coming years unless European countries find a way to make the region’s burgeoning retirement-age population more productive. At the same time, Europe’s export-dependency leaves it exposed to more external threats at a time when the outlook for international trade and investment is worse than it has been in decades. Productivity growth, which has been declining across Europe for decades, is unlikely to be reversed without major technological and process changes, few of which are likely to come from Europe. Meanwhile, the region’s failure to invest in high-tech, high-growth industries will continue to be a drag on growth and will further lessen the region’s competitiveness.

While the coronavirus pandemic has ushered in Europe’s worst economic slump since the Second World War, Europe’s economy was already in a period of relative stagnation before the pandemic hit. Now, this pandemic has exposed the fragility of many of Europe’s leading economies, much as the Financial Crisis did 12 years ago. As a result, Europe is unlikely to contribute much future growth to the global economy in the coming years, despite the fact that the region still accounts for one-fifth of total global economic output. With such a large economic center generating little or no growth in the years ahead, the repercussions will be felt around the world and Europe will prove to be a much greater drag on the global economy than Japan ever was.