Eurozone Showing economic resilience in the face of trade headwinds
4 minute read
13 August 2019
Resilient domestic demand contrasts weaknesses in global trade. The eurozone, therefore, continues the recent trend that combines a resilient services sector with struggling manufacturing industries. The question is: how long can this divergence last?
Diverging trends and moderate growth
The slowdown in the eurozone continues with an estimated growth rate of 0.2 percent in the second quarter,1 after 0.4 percent growth in the first quarter. Among the big eurozone economies, Spain showed the highest quarterly growth rate, and business and consumer sentiment in France rebounded. Germany grew stronger than expected in the first quarter due to a rebound of car sales after the production delays at the end of 2018, while the Italian economy has largely stagnated.2
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A very positive trend cutting across the eurozone relates to labor market performance—employment in the eurozone continues to grow. Currently, there are 159.5 million people employed in the eurozone—the highest level ever recorded. The number of persons employed has increased by 10.8 million in the euro area since 2013Q2.3 The unemployment rate was down to 7.5 percent in June, almost one percentage point less than a year before, and the lowest since July 2008.4
The strength of the labor market is matched with renewed wage-growth dynamics. While wages grew slowly for a long time, they are now picking up momentum and are growing at the strongest pace since 2011.5 Combined with still-low inflation, this should continue to support private consumption in the coming quarters (figure 1).
Powered by robust private demand, the services sector shows strong resilience and currently acts as the growth engine in the eurozone. Nonetheless, the industry sector remains weak, with industrial output being on a decline since early 2018 (figure 2). Therefore, the diverging trend of resilient services and a struggling industry sector continues in the eurozone.
The manufacturing recession
The overall weakness in manufacturing affects particularly the manufacturing-intensive economies of Germany and Italy. Industrial output in Germany and Italy has been on a broad downward trend since the middle of last year. A contributing factor to this parallel development could be the close integration of German and Italian industrial supply chains and their higher exposure to developments in the United States and China.6
Industrial output in France and Spain has not grown much either, but it shows a slightly positive trend over the same period (figure 3).
While strong domestic demand supports the services sector, it is investment and exports that usually drive the manufacturing sector. A deeper look at the key destination countries for the eurozone’s exports reveals that exports to the United States and China have stagnated since late 2018. Surprisingly, exports to the United Kingdom saw a sharp rise in the first quarter of 2019 (figure 4). However, this was probably due to temporary stockpiling in the United Kingdom in anticipation of the original Brexit deadline in late March. Without this temporary effect, exports to the eurozone’s major markets would have remained flat.
Without a rebound in world trade, exports alone will not to be able to drive manufacturing output and, therefore, growth in the eurozone. Current data and projections do not suggest a trade recovery any time soon. According to the World Bank, global trade growth will fall from 4.1 percent last year to 2.6 percent this year; the weakness in trade so far has affected mainly capital goods.7
Additionally, many corporates show a decreasing appetite for investment. While investment in construction is strong, that in equipment and machinery is growing considerably weaker than last year.8 In this sense, growth impulses for manufacturing from exports and investment remain weak at best.
Can manufacturing and services decouple forever?
The divergence between manufacturing and services seen currently is surprising. While the two sectors are usually driven by different kinds of expenditure, several service sector outputs are inputs into manufacturing; in other words, there is a spillover effect from manufacturing to services. However, in recent years, the correlation between the two industries has declined in almost all major economies.9
The reasons are manifold, but one key factor that impedes the spillover effects involves labor market trends. In almost all major industrialized countries labor markets are very tight. According to Deloitte’s European CFO Survey Spring 2019, labor shortage is one of the main risks for European companies; in Germany, the Netherlands, and Austria, they are the most important risk.10
In this situation, companies tend to hire or keep more employees than they usually would to protect themselves from the adverse effects of labor shortages.11 This employment security, however, comes possibly at the expense of productivity growth.12 Coupled with employment increases, especially in knowledge-intensive services, which are relatively immune to cyclical trends, the services sectors were likely able to increase their resilience.
As for the economic outlook in the coming next quarters, this implies that any positive or negative change in the labor market and private consumption could directly affect growth in the eurozone.
Deloitte Global Economist Network
The Deloitte Global Economist Network is a diverse group of economists that produce relevant, interesting and thought-provoking content for external and internal audiences. The Network’s industry and economics expertise allows us to bring sophisticated analysis to complex industry-based questions. Publications range from in-depth reports and thought leadership examining critical issues to executive briefs aimed at keeping Deloitte’s top management and partners abreast of topical issues.
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Get in touch
- Alexander Börsch
- Director
- Deloitte & Touche GmbH
- aboersch@deloitte.de
- +49 (0) 89290368689
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