At the moment so many events are focused on Europe. At the present headlines are being created by the war in Ukraine and possible changes as to how that may play out. On its own it poses challenges as in the new situation both the Euro area and European Union are going to have to pay more for their own defence rather than rely on the United States as a backstop. From our perspective of economics that suggests more government spending which is rather awkward when the Eurocrats have only recently returned to the plan of cutting it via the exhumed Stability and Growth Pact. An example from the European Commission is below.
France should thus put an end to the excessive deficit situation by 2029.
(3) The Council establishes the deadline of 30 April 2025 for France to take effective
action and present the necessary measures together with its 2025 annual progress
report, to be submitted to the Commission in accordance with Article 21 of
Regulation (EU) 2024/1263.
The French situation is especially complex. We had previously looked at the political situation partly caused by the planned cutbacks in spending. Now the same European Commission which has been telling France to cut spending is likely to be more than happy if it boosts defence spending as it is one of Europe’s main political powers.Along the way there may well be a boost for the French economy via its large defence sector. At some point there may well be a tacit acceptance that the treatment of the UK was a clear own-goal in this area.
Debt Costs
Bond yields are rising this morning reflecting the above with more perhaps noting this part of the European Commission report.
the European Commission Autumn 2024 Forecast, the general government debt would increase from 112.7% of GDP at end-2024 to 121.6% at end-2029.
This reflects a theme of my work where as an overall factor the western political class continues to be fiscally spendthrift. That adds to the French theme of a large government sector and also for good measure these forecasts invariably understate the risks.
The French ten-year yield is 3.19% today and whilst that is better than the “le spread” issue period it means that France is continuing to pay higher yields on its debt. Remember when the ECB financed it bu buying some many of its bonds under the APP and PEPP plans and sent many French bond yields negative? Now the situation is very different.
State debt service is expected to stand at €54.9bn.
Plus if we stay with data from the French Treasury we see that bonds are being issued at a high rate.
The financing requirement in 2025 will be met by (i) the medium- and long-term government debt issuance programme, net of buybacks, worth €300bn,
This provides upward pressure on debt costs as older cheaper borrowing is replaced by more expensive newer bonds. Along the way we note that last year France continued in a Hey Big Spender style.
The deficit to be financed in 2024 has been revised upwards to €166.6 bn, compared to the amount of €146.9bn provided for in the 2024 initial Budget Act promulgated in December 2023.
France is a bell weather in many ways for the Euro area these days as its debt has surpassed that of Italy. Or as a report from GIS put it.
France’s public debt last year reached an estimated 112 percent of its gross domestic product (GDP), accounting for one-fourth of total European Union public debt.
Economic Reform
This is an issue which the Eurocrats are now unable to look away from. Even the better news last week is a reminder of the issue.
In the fourth quarter of 2024, seasonally adjusted GDP increased by 0.1% in the euro area and by 0.2% the EU,
The trouble is that even an upwards revision leaves the annual figure around 2% short of the United States.
According to an estimation of annual growth for 2024, based on seasonally and calendar adjusted quarterly data, GDP increased by 0.7% in the euro area and by 0.9% in the EU.
Here is the US Bureau of Economic Analysis.
Real GDP increased 2.8 percent in 2024 (from the 2023 annual level to the 2024 annual level), compared with an increase of 2.9 percent in 2023.
Adding the 2023 numbers just increases the pain. Into this arena rode Mario Draghi over the weekend as he wrote an opinion piece in the Financial Times. He started by pointing out a clear weakness.
The first is the EU’s long-standing inability to tackle its supply constraints, especially its high internal barriers and regulatory hurdles. These are far more damaging for growth than any tariffs the US might impose — and their harmful effects are increasing over time.
How much? This much apparently.
The IMF estimates that Europe’s internal barriers are equivalent to a tariff of 45 per cent for manufacturing and 110 per cent for services. These effectively shrink the market in which European companies operate: trade across EU countries is less than half the level of trade across US states. And as activity shifts more towards services, their overall drag on growth becomes worse.
Oh and let me point out that even if these figures are from the ( European led) IMF they still might be true.
The European enthusiasm for regulation is also a problem.
At the same time, the EU has allowed regulation to track the most innovative part of services — digital — hindering the growth of European tech firms and preventing the economy from unlocking large productivity gains. The costs of complying with GDPR, for example, are estimated to have reduced profits for small European tech firms by up to 12 per cent.
The next major issue is something I have looked at many times over the years in relation to Germany in particular.
The second factor holding Europe back is its tolerance of persistently weak demand, at least since the global financial crisis of 2008. This has exacerbated all the issues caused by supply constraints.
On this road the much vaunted trade surpluses are as much a weakness as a strength.
The paradox is that while internal barriers remained high, external barriers fell as globalisation accelerated. EU companies looked abroad to substitute for lack of domestic growth and imports became relatively more attractive.
We can also look at this via the starting point which will be a year ago on Wednesday.
And weak demand has fed back into exceptionally weak total factor productivity growth after recessions, a pattern not seen in the US.
It was on that date that Isabel Schnabel raised the productivity issue.
Care however is needed because I have also pointed out over the years that the best way to mislead on fiscal policy is to use derivatives rather than overall numbers which I have highlighted below.
While the demand gap has different drivers, the most significant has been the relative stance of fiscal policies. From 2009 to 2024, measured in 2024 euros, the US government injected over five times more funds into the economy via primary deficits — €14tn versus €2.5tn in the eurozone.
Comment
There are elements here which are very welcome.
Both these shortcomings — supply and demand — are largely of Europe’s own making. They are therefore within its power to change.
Those who followed my articles on his time as President of the ECB will now that each policy announcement had a plea for economic reform. But it is also true that he if we add in his roles as Prime Minister of Italy and back in the day Governor of the Bank of Italy has been a leader when economic reform was on the back burner. Also his switch a bit over a decade ago to negative interest-rates and mass QE bond buying helped prop up zombie companies and banks.This reminds me that his “Draghi Laws” for the Italian banks was followed by an era of collapses and expensive taxpayer subsidies. Also if we look at the ECB balance sheet its holdings of French ( and other) bonds must look awful.
Into that mix we see that Europe has a failing in the area of defence too. Will it and indeed can it ever reform. Whilst the first step to dealing with a problem is to realise you have made mistakes are they all capable of this? Also one of the biggest economic handicaps is the high energy costs driven by the same people.
