The first chart on the Euro Area shows the profile of GDP, of Internal Demand (ex inventories) and of private internal demand (Internal demand less government expenditures). To ease the comparison every indicator is at 100 during the first half of 2008 (before the Lehman crisis)
All this indices are currently trending downward. After a rebound after the 2008/2009 recession, they decline again.
GDP had a peak during the third quarter of 2011 but is now -0.6% below this level
Internal Demand (Consumption + Investment + Government Expenditures) has had a peak in the first quarter of 2011 but is now -1.9% lower
Private Internal Demand has a peak in Q1 2011 but is now -2.3% lower than at this peak.
The main weakness of this chart is this downward trend for private expenditures. Neither consumption nor investment are improving since the Q3 2011 peak. Consumption expenditures are -1.5% lower and Investment is -4.7% lower.
The main root of this profile is the adoption of restrictive policies in different countries (Italy, Spain, Portugal). They have changed the profile of after tax income. This latter had usually a negative trend. After tax income were reduced and led to lower income purchasing power.
The negative impact was immediate on consumption expenditures. This led to a low level of demand and as a consequence there was jobs losses. This has created higher uncertainty and weakened demand.
Companies in this environment did not want to spend too much on investment. As the main driver for investment is expected demand, the scheme for European companies was bleak (at the same time external demand was not strong)
We can add that during this period uncertainty about the institutional framework for the Euro Area led to a wait and see behavior. As a matter of fact, when a company is in face of this kind of uncertainty they prefer waiting before investing. (what could happened if euro area blows? Nobody knows and then companies try to minimize this risk)
In the chart, austerity policies push downward the blue and the purple lines. Private expenditures have a negative trend and government expenditures do not change this trend
The sole question is the following : what could change the trend of this internal demand?
Sometimes we can hear that this will lead to a kind of salvation (a purge that will help for recovery on strong foundations. That was what medicine said in the Middle Ages when they wanted to bleed someone to help him to recover. Usually the guy was dead before recovering) but this ignores that a lower activity will lead to higher unemployment and a risk of social and political unrest. We know that this phenomena is not linear but we don’t know ex ante the threshold that will lead to a deep change in the picture.
What could change in 2013?
The new institutional framework must lead to a more stable system as it has been built to keep all the countries within the Euro Area. This could be good for investment. Nevertheless, the banking union has been postponed and uncertainty reduction will be limited.
More austerity policies (in France) will not reverse the downward momentum. We cannot expect that this will change people confidence. We know that it is supposed that more commitments from the government can change private actors’ behavior. It is more a theoretical point of view that an empirical one. Usually it does not work.
The point is that the speed reduction to budget deficits mustn’t be as quick as it is expected. Everyone will do the same thing at the same moment.
We cannot spontaneously imagine that in 2013 the external environment will change and give a strong impulse to euro economic activity. Neither the USA nor China will create an impulse that could deeply change the Euro Area economic profile.
In that case if no one wants to spend, who will address a stronger demand to companies? No one and that the risk of a new recession and higher unemployment
On the second chart the same indices are shown for the USA. The picture is totally different. Internal demand is strong and is pushed up by private expenditures. There is no austerity policy (budget deficit was 7% of GDP for the 2011/2012 fiscal year)
The question we have to ask in Europe is the following: If I have to invest (in a factory) where will I spend my money? Looking at the two charts the answer is easy except if the Euro Area changes its strategy very deeply