A gulf has opened between the US and the eurozone, the world’s two largest economic blocs. On the one side, recent data from the US points to an economy in robust health. Growth has now surpassed the Federal Reserve’s estimate of the 1.8% long-term sustainable pace for each of the past six quarters and looks on track to do so again in the first months of 2024. And with American companies leading the way in emerging technologies such as artificial intelligence (AI), economists are increasingly upbeat about the outlook for the decade ahead.
Sadly, optimism over the eurozone economy is in short supply. The region avoided a recession by the skin of its teeth last year, with GDP stagnant in the final three months of 2023 after a 0.1% fall in output in the previous quarter. Worse still, economists are generally glum over the prospects of the region in 2024 and beyond.
Counter-intuitively, more investment may be required, not belt tightening
So why is the US outshining the eurozone? And how can finance chiefs at eurozone companies cope with sluggish growth and help improve the region’s fortunes? The counter-intuitive answer may be more investment spending rather than belt tightening.
Cyclical factors
The eurozone’s malaise has both short-term and structural elements. On the cyclical front, it is facing three important headwinds, says Andrew Kenningham, chief European economist at Capital Economics. First, there has been the effect of the energy crisis. The reduction in supplies of cheap Russian gas following the invasion of Ukraine has had a far more pronounced effect on the eurozone economy than US – which has been a net energy exporter since 2019.
While government support shielded the region from the worst effects of the surge in energy prices in 2022, the squeeze on household spending power was still considerable. Output from energy-intensive industries – such as chemical and metals – has not recovered from the shock, even though gas prices have subsided. It seems likely that much of this production will never return.
The eurozone is now looking to restore greater fiscal discipline
Second, fiscal policy in the eurozone is on track to tighten in 2024 and beyond. Kenningham says: ‘The US was much more generous in fiscal support than the eurozone during Covid-19 and has not tightened much at all. The eurozone is now looking to restore greater fiscal discipline. Aside from a cultural aversion to borrowing in nations such as Germany, there is also an eagerness to avoid debt divergences from pulling the single currency area apart – as seemed like a growing risk between 2010 and 2016.’
Third, the European Central Bank looks likely to keep its deposit rate at a record high of 4% at least for most of the first half of this year. While the ECB now only expects the region’s economy to grow by 0.6% this year, top policymakers have continued to expressed their determination that inflation will return to the 2% target before policy is eased.
Structural forces
‘The current funk won’t last forever,’ says Kenningham. ‘But a bigger worry comes from some of the structural forces that are holding the eurozone back.’ Europe faces a more acute demographic challenge than the US, with a shrinking working-age population.
Perhaps even more critical is that the strengths of the eurozone economy lie largely in older industries, rather than in tech. ‘Even in industries where Europe has had a commanding position, such as autos, companies have often been slower to embrace new trends,’ says Kenningham. When it comes to electric vehicles, most industry experts would agree that in the US car manufacturer Tesla and Chinese producers such as BYD have established a lead.
And in the industries of the future, the eurozone appears to be lagging even further behind. Venture capitalists in the US ploughed an estimated US$450bn into AI over the past decade, according to the OECD, close to 10 times more than the eurozone or the UK. ‘It is also concerning for the eurozone that China has managed to leapfrog over Europe in terms of innovation in key parts of the tech sector,’ Kenningham adds.
CFO challenge
So how can business executives and finance chiefs in the eurozone address the challenge? This will clearly depend on the industry. For many older energy-intensive industries, the answer may be managed decline: scaling back investment, shifting production and trimming staff. Just as the textile industry ceased to be competitive in the region, some parts of the metals and chemicals industry may no longer be viable. Almost one in 10 German chemical producers surveyed late last year by the VCI industry association say they intend to end production in the country.
But elsewhere the opposite solution could be more appropriate – a boost to investment and a focus on the industries of the future. The 2023 IMD world digital competitiveness ranking, which evaluates the readiness of 64 economies to adopt digital technologies, placed the US first. Europe’s largest nations trailed far behind, with Germany 23rd, France 27th and Italy 43rd. There are, however, role models within the eurozone that others could learn from, including the second-ranked Netherlands.
‘Businesses and governments in the eurozone clearly need to up their game’
On the bright side, Germany remains a leader in deploying automation and robotics in its factories, with the third highest density in the world, according to the International Federation of Robotics.
Maintaining such investment is likely to be critical if, as the UN forecasts, the working age population continues to contract. But the example of the auto industry, where the eurozone has trailed the US and China in electrification, is a reminder that state-of-the-art production techniques need to be geared toward the next generation of goods and services.
‘The eurozone economy has a lot of cards to play and can certainly compete in innovation,’ says Kenningham. ‘But businesses and governments clearly need to up their game as they prepare for a changing world.’
