The recovery in the U.S. economy is real and sustainable. Driven by the private sector, and notwithstanding the withdrawal of quantitative easing (QE), U.S. domestic demand is growing at a steady clip. Growth reached 3.5 per cent at an annual rate in the third quarter and should exceed 3 per cent in 2015. Not surprisingly, sectors such as housing and autos are recovering nicely, as is private investment. Lower gasoline prices will free up extra cash for families to spend as the holiday season approaches.
Our colleagues at the Conference Board in New York provided the latest piece of evidence, with U.S. consumer confidence jumping sharply in October. America is back in business and Canada is along for the ride.
As I learned last week when I was part of a Canadian mission to attract European direct investment, economic sentiment on the other side of the pond is strikingly different to that in North America. And there is little reason to believe that the growing performance gap between Europe and North America will close any time soon.
The European economy remains the sick man of the global economic outlook. We expect real gross domestic product in the euro zone to expand by less than 1 per cent this year and a gain of only 1.4 per cent is anticipated in 2015. Although the public sector debt crisis has been stabilized for the moment, economic growth is stumbling once again across the euro zone, raising concerns of another flare-up in financial markets. Europe is far from a sustained recovery and there is still an unwillingness to consider the fundamental microeconomic reforms that would be required to kick-start growth.
Let's examine the key elements of Europe's economic performance and policy. The core public policy debate remains the effort to get fiscal policies under control in many heavily indebted countries and the "austerity" that ensues. It is entirely true that rapid fiscal adjustment in countries like Greece, Italy and Spain is not good for growth. But these countries are still running material fiscal deficits (adding to their already large public debt) and their access to private market financing is being squeezed, putting their borrowing spreads in jeopardy. In these circumstances, there are few other fiscal options available; there is no magic "financing fairy" that provides unconditional credit forever.
Yet, at the same time, there has been remarkably little focus on the real potential source of renewed economic growth in Europe – microeconomic or structural reform. Although new prime ministers in France and Italy have finally raised the need for reform, interest groups continue to oppose reforms to labour markets that would make it more attractive for European firms to hire young people. Youth unemployment rates are above 40 per cent in Spain, Italy and Greece – a shocking level for mature economies.
Pension and social policy reform lags, as does reform to the regulatory underpinnings of the financial sector. Rapidly-aging populations mean stagnant or even negative labour force growth, but there is little appetite for an informed debate on immigration policy to replenish the work force. To the contrary, far-right populist politicians are pushing an anti-immigrant agenda, and the European politician spectrum appears to be slowly accommodating that view.
Central banks have been asked to carry an exceptional portion of the load to shore up European growth, but have been reluctant to go all-in. European Central Bank head Mario Draghi said last year that he would do "whatever it takes" to sustain the EU economy. In truth, the ECB has been slow to cut rates aggressively, and has balked at making the same aggressive moves as the U.S. Federal Reserve and Bank of Japan by stepping boldly into quantitative easing. Even other European banks have shown a bit more boldness than the ECB; the Swedish central bank just cut the bank rate to zero in a bid to stave off deflation.
As an added complication, nearly 25 European banks have inadequate capital to withstand another shock to the financial system, according to the ECB's own shock test to capital adequacy. Remarkably, some observers have given a positive spin to this news, noting that "only" about 25 banks remain undercapitalized. Add it together and we find a European economy where growth is again flagging and public debt is barely under control. Yet, most political leaders and the public that elected them are still dithering over the bold steps required to reinvigorate economic growth. Canada's pursuit of free trade with Europe offers numerous benefits to both parties, but Canadian businesses cannot count on strong growth in these markets. To succeed, Canadians firms will need to take market share from competitors by being more innovative, and consistently tweaking their products and services.
Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.