Euro area economic performance has been subdued since around 2018. This column outlines how this subdued performance underscores the multifaceted challenges of energy dependency, manufacturing vulnerabilities, and shifting global trade dynamics. Manufacturing has struggled amidst rising energy prices, which intensified export declines in high natural gas-intensive sectors. Shifting trade dynamics with China – characterised by increased euro area imports and decreased exports – compound these challenges.
Euro area economic performance has been subdued since around 2018, and especially so in more recent years. As discussed in Revoltella (2019) and in the Draghi Reports (Draghi 2024a, 2024b), the euro area economy faces notable structural challenges that were exacerbated by the pandemic and the disruption to energy markets that ensued from the Russian invasion of Ukraine. This contrasts with the recent strength in the US economy, which did not suffer as much from the energy shock and continues to be supported by strong government spending. 1
On the demand side, this divergence is most clearly evident in consumption, as shown in Figure 1, as households accumulated significant excess savings amid elevated uncertainty (de Soyres et al. 2023). Moreover, as noted in de Soyres et al. (2024), the gap in output performance between the US and the euro area can be traced to a divergence in labour productivity, likely reflecting under-utilisation of labour within firms stemming from weakness in aggregate demand. 2
Manufacturing woes
Figure 1 reveals significant geographical disparities in economic performance amongst European economies, especially between the protracted stagnation in the manufacturing-heavy and natural gas-dependent German economy and the recent strength in the services and tourism-oriented Spanish economy.
Figure 1 Economic performance
In the left panel of Figure 2, we relate cumulative economic growth in 2015–2019 to the share of manufacturing in total value-added at the beginning of that period. We see that during that period, the share of manufacturing did not correlate with overall economic performance. The right panel of Figure 2 repeats this exercise for the more recent period encompassing data between 2022:Q1 and 2024:Q3. Strikingly, the strong negative association reveals that manufacturing share is correlated with poor economic performance of the last few years (the right panel of Figure 2 features a negative slope of -0.4, statistically significant at the 5% level).
Figure 2 GDP performance and manufacturing share in the Euro area
There are many reasons why manufacturing is reeling in the euro area. For example, Ruslana and Fleck (2024) highlight that monetary policy might have been an important factor, as high interest rates depressed economic activity more in euro-area countries with large manufacturing sectors. Additionally, the unprecedented energy shock of 2022 might also have played a role.
Energy prices and natural gas dependence
The euro area underwent unprecedented energy market disruptions that ensued from the Russian invasion of Ukraine (Gil Tertre et al. 2023). As shown in Figure 3, Brent and European natural gas prices spiked in 2022, resulting in large increases in consumer and producer energy prices. While commodity prices have largely retraced their previous increases – Brent and TTF natural gas spot prices still stand 17% and 117% higher, respectively, than their 2017–2019 average – this reversal did not fully pass-through the energy components of CPI and PPI in the euro area, which remain about 50% to 60% above pre-pandemic levels. There is notable heterogeneity across countries, with Germany standing out as the country where energy PPI remains the highest, above twice its pre-pandemic level.
Figure 3 Energy prices
To investigate the role of the natural gas shock in the ongoing economic weakness, we turn to sectoral data across several European economies and compute natural gas intensity, defined as terajoules of natural gas usage per euro of value-added output for nine sectors across four economies, and relate this metric to export performance across two time periods, as shown in Figure 4.
Figure 4 Natural gas intensity and export performance
Prior to the energy shock and the pandemic, there was no statistically significant relationship between export growth and natural gas intensity (left panel). However, this relationship changed significantly amidst the energy-price shock, with export growth for sectors in the top decile of natural gas intensity declining on average 7.2%, contrasting starkly with the export growth in sectors at the bottom decile of natural-gas intensity, which on average experienced export growth of 13.8% (right panel; the panel features a slope of -1.6, significant at the 1% level). Interestingly, the negative association between natural gas intensity and export performance also holds when only looking at sectoral variations within countries.
The role of China
Since 2018, Chinese officials have been emphasising the need for China to achieve greater self-reliance. As discussed in Dieppe et al. (2019) and de Soyres and Moore (2024), China seems to have made some progress towards the goal of decreasing its reliance on imported inputs, while actually increasing its reliance on foreign demand to absorb its production of manufacturing goods.
The consequences of China’s development strategy can be seen in the evolution of its imports from and exports to the euro area in general, and Germany in particular. In Figure 5, the top left chart shows that euro-area imports from China increased to 3.3% of euro-area GDP from 2.5%, while the top right chart reveals that the Chinese imports from the euro area (as a share of euro-area GDP) decreased by almost half in the same period. Focusing on Germany in the bottom row, the same pattern is at play, with Germany increasing its imports from China (as a share of German GDP) by 44% while China decreased its imports from Germany (as a share of Chinese GDP) by almost half.
Figure 5 Trade linkages with China
As China tries to continue to reduce its import dependency, can exports to China remain a tailwind for growth for euro area countries? Figure 6 explores this question by looking at the association between GDP growth and the share of exports to China over three different time periods. During 2014–2016, exposure to China as an export destination was not correlated with economic performance. However, the relationship gradually turned negative in the past few years, as stronger export links with China were associated with mildly lower GDP growth in 2017–2019 and a more pronounced weakness in 2022–2023 (In Figure 6, the middle panel shows a negative slope of -0.2 [statistically significant at the 5% level], and the right panel shows a negative slope of -0.5 [statistically significant at the 1% level]).
Figure 6 GDP performance and exports to China in the euro area
Conclusion
The subdued economic performance in the euro area underscores the multifaceted challenges of energy dependency, manufacturing vulnerabilities, and shifting global trade dynamics. While structural issues and external shocks have significantly impacted economic performance, understanding the interplay between energy prices, sectoral dependencies, and global trade relationships remains critical.
Source : VOXeu
