A lack of access to cheap energy has made the continent less competitive
Last week Germany announced that, after the government statistics agency revised its recent GDP figures, it was clear that the country was in recession. In recent history it has tended to hold up well as the global economy softened relative to some of Europe’s weaker economies. But this time it seems that Germany is leading the pack into recession.
This is because the recession that is currently looming over Europe is fundamentally different from previous iterations. The coming recession is no simple turning of the business cycle. Instead, it could be the beginning of the deindustrialisation of the European economy, which no longer has access to cheap Russian energy.
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Since chatter about deindustrialisation started last year, there has been much confusion on the matter. Some appeared to think that deindustrialisation would mean the instantaneous closure of energy-starved European factories and mass layoffs. Others assumed that the crisis was over because energy futures prices have fallen in recent months.
Deindustrialisation is not something that happens overnight. Rather, it is a gradual process whereby European industry becomes less competitive on the global market, as higher energy costs are passed through in the form of higher prices. We saw something similar happen in Britain in the 1990s, as many factories shut down and few reopened. But the potential deindustrialisation of Europe will probably be more rapid than the British example.
As for energy prices returning to normal, this seems unlikely. Last week the head of Britain’s energy regulator admitted that energy bills were unlikely to fall to pre-crisis levels for at least two years. By all accounts, the regulator is likely being optimistic. Qatar’s energy minister warned around the same time that the “worst is yet to come” for European oil and gas shortages. He would probably know, since Europe is relying heavily on Qatari LNG imports for their energy supplies.
Quantifying the impact of deindustrialisation at this early stage is quite difficult and a clear picture will only emerge in retrospect. But there are already some very notable trends in the data. The German services sector is booming while the manufacturing sector is cratering. This divergence explains why the German economy is currently experiencing only a very shallow or even “technical” recession.
Bluntly, the current contraction we are seeing in Germany’s manufacturing sector relative to its services sector is associated with a much larger downturn — something along the lines of what followed the 2008 financial crisis. Today we are seeing a very large relative contraction in the manufacturing sector that cannot be explained by the relatively modest weakening of the economy.
Put differently: the current manufacturing crunch in Germany is not primarily being driven by Germany’s slack economy. This means that something else is to blame and that something is likely the high energy prices putting enormous pressure on German manufacturing.
German and European deindustrialisation is not yet certain. There is a chance that, after the war in Ukraine is over, the Europeans turn once again to Russia for their energy needs. But right now, in the current diplomatic environment, this seems unlikely. If the current trajectory is followed for the next five to 10 years, however, it seems fairly certain that Germany and Europe will deindustrialise to a significant extent.