“Other incentives such as maternity leave, tax breaks and child care centres have been tried around the world, however it takes at least a generation to be fully efficient and these measures are not easy steps to increase fertility,” Campbell says.
The demographic profile in the eurozone, which means some populations are stagnant while others, including Europe’s power- house of Germany, are declining, is a significant part of why inflation in Europe is struggling to gain traction.
PRODUCTIVITY GAINS
Some of the eurozone’s slowing growth prospect could be offset by productivity gains, but the outlook remains sombre.
A combination of policies focused on improving productivity and the incentives to locate economic activity in Europe, both in services and manufacturing, would help.
“Given a flexible, competitive workforce there is no reason why inward investment would not flow into Europe, offsetting some of the [demographic] headwinds,” says Alastair George, investment strategist at Edison Investment Research, but he adds: “We are of course at present some way from this ideal.”
Increasing productivity means capital expenditure by corporates, but so far this has largely failed to materialise. Balance sheets have contracted nearly $1trn since their peak in 2012 and have only just started expanding again.
“Fundamentally, why would corporates invest at the moment?,” Campbell asks. “Growth is weak for the foreseeable future and there is little in the way of structural reforms that eases business operations. Rates might be low, but borrowing at 1-2% only works if return is higher than that.”
Stewart Richardson, CIO of RMG Wealth Management, argues: “Europe needs to increase capital expenditure to increase productivity, but the current policy mix is wrong. Any wiggle room purchased by the ECB’s balance sheet expansion initiatives is being wasted by governments. The weaker currency is also likely to be wasted by corporates as they will simply bank the currency gain. The outlook is pretty bleak.”
Yet without productivity gains, the demographic profile of the region will continue to limit growth. In turn, it will struggle to surmount its massive debt problem.
DEBT
“There isn’t a scenario where countries can grow or inflate their way out of this [debt/ GDP ratio] issue,” Campbell says.
Government debt increased to 93.9% of GDP in the euro area in the first quarter of 2014, up from 92.5% a year earlier, according to Eurostat data. Germany’s debt/GDP ratio has fallen just over 3% to 77.3%, but debt/GDP in Greece, Italy, France, Portugal and Spain all rose over the year to 175%, 136%, 97%, 133% and 97% respectively by the end of March 2014.
Relying on economic growth to reduce debt levels is naturally very difficult in a low-inflation, low growth environment where demographics are not favourable. Furthermore, if governments are not able to reduce the burden, they will have less scope to deal with future shocks.
RBC’s Lascelles believes eurozone debt levels will likely remain very high for several more decades, meaning that future recessions could be deeper than otherwise expected since governments are unable to deliver the usual dose of fiscal stimulus.
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