|Mario Draghi, ECB president, officially opening the ECB's new Frankfurt premises, Mar 18, 2015
An ESRI research note published today says long-term growth prospects for the Euro Area are grim even if unemployment and investment return to their pre-crisis rates by 2020.
The research note authored by Kieran McQuinn, associate research professor, Economic and Social Research Institute, and Karl Whelan, professor of economics, University College Dublin, is based on joint ESRI-UCD work entitled “Europe’s long-term growth prospects: With and without structural reforms,’’ updates earlier calculations by the same authors in a 2008 paper and provides projections of Eurozone growth out to 2060, based on recovery scenarios related to the 2008 economic crisis and long-term demographic trends. The research on which the note is based also examines the implications of three significant structural reforms on European growth rates.
Overall, the authors say the findings are sobering for those expecting economic growth to deal with the Euro Area’s debt problems over the next decade. Among the results reported are the following:
1. The working age (15 to 64) population of the Euro Area has been declining since 2010.
2. An average real GDP growth of just over half of one per cent per annum over the next decade is projected even if unemployment and investment return to their pre-crisis rates by 2020.
3. The adoption of significant and ambitious labour market as well as product reforms across the Euro Area would improve GDP growth by just 1% per annum.
4. The research concludes by calling for a significant joint Euro Area funded capital investment programme which would address the large output gap and increase the supply-side potential of the European economy.
The note also says that Total Factor Productivity (TFP) growth in the Euro Area has almost ground to a halt: it averaged 0.2% per year over the period 2000-2013 while the ongoing slump in investment is having negative supply-side effects: low capital stock growth is subtracting about 0.6% per year from potential output growth.
Kieran McQuinn said: "Over the longer-term, Europe needs a plan for dealing with a pattern of population ageing that is set to have enormous effects on its growth potential. Policy initiatives to delay retirement ages and to encourage labour force participation are undoubtedly part of the solution to the problems posed by ageing. However, these initiatives are likely to be very unpopular politically and may have negative implications for productivity. A policy of large planned increases in the amount of immigration into the EU, while also politically challenging, may turn out to be the only way to keep the European economy expanding in the future.”
UK "underlying growth has stopped"
Last December Dr Martin Weale, a member of the Bank of England Monetary Committee (MPC), compared the UK’s recent productivity growth to that of other developed countries and considers what their experiences might tell us about the causes of weak productivity.
He said in a speech that “the UK is not alone in having weak productivity growth recently.” In fact, the relationship between pre and post crisis productivity in the UK is similar to that of twenty-three other developed countries, suggesting “our experience is far from unique”. And, like the UK, these countries now have productivity growth rates which are “at best only very weakly correlated with those in the period before the crisis.”
Turning to the implications for monetary policy should productivity growth be weaker than the MPC expects, Dr Weale noted: “Persistently slower productivity growth would have two implications for interest rates; in the short term, interest rates would need to be higher in order to prevent demand running ahead of supply. But over the medium term, interest rates may remain lower than they were before the crisis, reflecting weaker underlying growth.” However, “the MPC does not have the luxury of being able to wait for the fog of uncertainty over productivity growth to clear up. Exploration of recent trends provides some help, but understanding what they imply for the future remains essentially a matter of individual judgement.”