The end of the eurozone's long recession has been met with relief by its policy-makers, with some jumping on the news to justify their management of the eurozone crisis. They argue that the eurozone economy is on the mend, and the recovery will gain momentum over the coming quarter. If they are right, then the outlook for the euro has indeed improved: faster growth will make it easier for countries to service their debt, bring down unemployment and help contain political populism. Unfortunately, their optimism is almost certainly misplaced. The basic problem is that the world cannot accommodate a Europe refashioned in Germany's image.
Economists should always be wary of extrapolating from a period of exceptionally bad economic performance. Economies do recover, as the sudden jump in the UK's growth rate over the course of 2013 shows. But there are reasons to doubt that the eurozone's return to growth in the second quarter of 2013 (ending six consecutive quarters of contraction) is the start of an economic rebound strong enough to get on top of debt ratios and bring down unemployment.
First, so far the recovery is not worthy of the name. The eurozone expanded by just 0.3 per cent, and will have grown at best by a similar amount in the third quarter. At that pace it will take two and a half years for the eurozone to regain its pre-crisis size.
Second, the return to growth hardly vindicates the eurozone's austerity strategy; growth in the second quarter was boosted by an easing of fiscal austerity. Investment did pick up marginally, bringing to a close eight consecutive quarterly declines. However, investment was still down almost 4 per cent compared with the previous year. Private consumption, meanwhile, was lower in the second quarter of 2013 than the first. The biggest contribution to growth came from net exports (growth of exports outpaced that of imports).
This is not the basis of a sustainable recovery. It is highly unlikely that fiscal policy will continue to make a positive contribution to growth beyond the third quarter of 2013. Many eurozone economies are falling behind on their deficit reduction targets, and will therefore come under pressure to tighten policy. Germany has indicated that it has no intention of imparting any fiscal stimulus, despite running a budget surplus and the German economy barely expanding (the Deutsches Institute für Wirtschaftsforschung, for example, expects growth of just 0.2 per cent in the third quarter). Fiscal policy may not act as a major drag on economic activity across the eurozone over the next few years but neither will it be a source of economic growth.
Net exports have kept the eurozone economy afloat. Between the trough of the crisis in the second quarter of 2009 and the second quarter of 2013, the eurozone economy expanded by 3 per cent. Over this period domestic demand fell by 0.7 per cent. Put another way, all the growth the eurozone enjoyed was dependent on demand generated outside of the currency union; without it the eurozone would have continued to shrink.
The result has been a big swing in the eurozone's current account position. In 2008 the eurozone had a deficit of around €85 billion (less than 1 per cent of GDP); it is on course to have a surplus of close to 2.5 per cent of GDP in 2013. Eurozone policy-makers cite this shift as evidence of improved competitiveness. The truth is simpler: falling eurozone domestic demand hit demand for imports, whereas rising demand around the world boosted demand for eurozone exports.
It is a moot point whether the external surplus can continue rising. Leaving aside the fact that the eurozone is flouting its G20 commitments to prevent the growth of large trade imbalances, it is probably already hitting the limits of the possible. The eurozone is simply too big an economy for the rest the world to keep it afloat. A surplus of 2.5 per cent of eurozone GDP already comprises a big drag on the global economy, which the eurozone in turn is increasingly dependent upon.
Much of the growth in eurozone exports over the last ten years has come from emerging markets. For example, between 2002 and 2012 eurozone exports to China rose fourfold. But that growth has now slowed rapidly - over the first six months of 2013 exports to China were less than 1 per cent higher than a year earlier. It is a similar story with exports to Latin America and Central and Eastern Europe. The share of the eurozone's total exports accounted for by the US and UK has fallen to less than a quarter, so modest economic recoveries in those two countries will not boost eurozone exports that much.