Europe Economy Sector Profile

• Pre–1945: Industrial growt
• Europe Economy Sector Profile

     The economy of Europe comprises more than 831.4 million people in 48 different states. Like other continents, the wealth of Europe's states varies, although the poorest are well above the poorest states of other continents (except Australia) in terms of GDP and living standards. The difference in wealth across Europe can be seen in a rough East-West divide. Whilst Western European states all have high GDPs and living standards, many of Eastern Europe's economies are still rising from the collapse of the communist Soviet Union and former Yugoslavia. Throughout this article "Europe" and derivatives of the word are taken to include selected states whose territory is only partly in Europe – such as Turkey and the Russian federation – and states that are geographically in Asia, bordering Europe – such as Azerbaijan and Cyprus.

       Europe was the first continent to industrialize – led by the United Kingdom in the 18th century – and as a result, it has become one of the richest continents in the world today. Europe's largest national economy is that of Germany, which ranks fourth globally in nominal GDP, and fifth in purchasing power parity (PPP) GDP; followed by France, which ranks fifth globally in nominal GDP and sixth in PPP GDP; the United Kingdom, ranking sixth globally in nominal GDP, followed by Italy. The end of World War II has since brought European countries closer together, culminating in the formation of the European Union (EU) and in 1999, the introduction of a unified currency – the euro. If the European Union was taken as a single country, today it would be the world's largest economy – see List of countries by GDP. Europe is the world's richest region as measured by assets under management with over $32.7 trillion compared to North America's $27.1 trillion.

As a continent, the economy of Europe is currently the largest on Earth and it is the richest region as measured by assets under management with over $32.7 trillion compared to North America's $27.1 trillion. As with other continents, Europe has a large variation of wealth among its countries. The richer states tend to be in the West; some of the Eastern economies are still emerging from the collapse of the Soviet Union and Yugoslavia.

The European Union, an intergovernmental body composed of 27 European states, comprises the largest single economic area in the world. Currently, 16 EU countries share the euro as a common currency. Five European countries rank in the top ten of the worlds largest national economies in GDP (PPP). This includes (ranks according to the CIA): Germany (5), the UK (6), Russia (7), France (8), and Italy (10).

Pre–1945: Industrial growth

Capitalism has been dominant in the Western world since the end of feudalism. From Britain, it gradually spread throughout Europe. The Industrial Revolution started in Europe, specifically the United Kingdom in the late 18th century, and the 19th century saw Western Europe industrialise. Economies were disrupted by World War I but by the beginning of World War II they had recovered and were having to compete with the growing economic strength of the United States. World War II, again, damaged much of Europe's industries.

After World War II the economy of the UK was in a state of ruin, and continued to suffer relative economic decline in the following decades. Italy was also in a poor economic condition but regained a high level of growth by the 1950s. West Germany recovered quickly and had doubled production from pre-war levels by the 1950s. France also staged a remarkable comeback enjoying rapid growth and modernisation; later on Spain, under the leadership of Franco, also recovered, and the nation recorded huge unprecedented economic growth beginning in the 1960s in what is called the Spanish miracle. The majority of Eastern European states came under the control of the USSR and thus were members of the Council for Mutual Economic Assistance (COMECON).

The states which retained a free-market system were given a large amount of aid by the United States under the Marshall Plan. The western states moved to link their economies together, providing the basis for the EU and increasing cross border trade. This helped them to enjoy rapidly improving economies, while those states in COMECON were struggling in a large part due to the cost of the Cold War. Until 1990, the European Community was expanded from 6 founding members to 12. The emphasis placed on resurrecting the West German economy led to it overtaking the UK as Europe's largest economy.

With the fall of communism in Eastern Europe in 1991 the Eastern states had to adapt to a free market system. There were varying degrees of success with Central European countries such as Poland, Hungary, and Slovenia adapting reasonably quickly, while eastern states like Ukraine and Russia taking far longer. Western Europe helped Eastern Europe by forming economic ties with it.

After East and West Germany were reunited in 1990, the economy of West Germany struggled as it had to support and largely rebuild the infrastructure of East Germany. Yugoslavia lagged farthest behind as it was ravaged by war and in 2003 there were still many EU and NATO peacekeeping troops in Kosovo, the Republic of Macedonia, and Bosnia and Herzegovina, with only Slovenia making any real progress.

By the millennium change, the EU dominated the economy of Europe comprising the five largest European economies of the time namely Germany, the United Kingdom, France, Italy, and Spain. In 1999 12 of the 15 members of the EU joined the Eurozone replacing their former national currencies by the common euro. The three who chose to remain outside the Eurozone were: the United Kingdom, Denmark, and Sweden.

Regional Economic Outlook: EUROPE
Navigating Stormy Waters
October 2011

Introduction and Overview

Following a barrage of unfavorable shocks in the first half of 2011, global economic activity has weakened and has become more uneven. A devastating earthquake and tsunami in Japan disrupted global manufacturing; the Arab spring drove up oil prices; financial strains in euro area financial and sovereign debt markets deepened; growth in the U.S. decelerated sharply; and the standoff about raising the ceiling on U.S. government debt sapped confidence in policy making. Against this backdrop, projections for global growth have been revised downward, especially for advanced economies. The October 2011 World Economic Outlook projects real GDP growth worldwide at 4.0 % for 2011and 2012—about ½ %age point lower than projected in the April 2011 edition.

In Europe, the recovery lost steam in the second quarter, after a surprisingly strong first quarter, with growth in many countries coming to a near stand-still. The deceleration was partly the result of global shocks, which affected mostly those countries in Europe that had benefited so far from the strong global recovery. Yet it was also the result of the escalation of the euro area crisis, which is having a more wide-spread effect on domestic demand, as the confidence shock spreads beyond the periphery to core countries’ consumers, bankers, and investors.

This growth for all of Europe to slow down from 2.4 % in 2010 to 2.3 % in 2011, and further to 1.8 % in 2012 (Table 1). Inflation is likely to decline from 4.2 % in 2011 to 3.1 % in 2012, amid remaining economic slack and commodity prices that retreat from their peaks in early 2011.

Real economic activity in advanced Europe is projected to expand by 1.6 % in 2011 and 1.3 % in 2012. In the wake of the global crisis in 2008/09, advanced European economies recovered at different speeds. Some economies experienced tepid growth, hindered by high private indebtedness, a burst in asset prices, weak credit owing to banks’ funding difficulties and private-sector deleveraging, and lost competitiveness. Meanwhile, many others—such as Germany or Sweden—free from major imbalances, took advantage of their strong initial competitiveness positions to ride the global recovery wave in 2010, barely affected by the turmoil in the euro area periphery. This tiering is now fading, and the most recent indicators point to a general convergence toward low growth. Countries under market pressure will continue to suffer from deeper fiscal austerity measures, sharper private-sector balance sheet deleveraging, and more severe structural unemployment, with Portugal and Greece expected to remain in recession until mid-2012 and early 2013, respectively. In Italy

and Spain, higher interest costs on the sovereign debt, front-loaded fiscal adjustment, and increased tensions surrounding banks will constitute additional drags on already soft activity. Meanwhile, weaker global growth momentum will weigh on northern euro area countries, slowing the closing of their output gaps and the improvement of their labor markets. Germany, for instance, will see its growth pace halved from 2.7 % in 2011 to 1.3 % in 2012.

Growth in emerging Europe is projected to remain unchanged from last year—at 4.4 % in 2011—and then to decline to 3.4 % in 2012, as rebounds run their course and the global slowdown makes itself felt. Growth differentials within emerging Europe, which had been large in 2009 and 2010, are set to diminish. This reflects both a pickup in the Baltic countries and southeastern Europe—regions that had been most severely affected by the global crisis of 2008/09—and a slowdown of domestic demand growth in countries that hitherto expanded the fastest, such as Turkey and the European CIS countries. Nonetheless, significant differences remain in countries’ cyclical positions—output gaps in Poland and Turkey are closed or positive, while activity of many other countries has yet to return to precrisis levels.

Given persistent tensions in euro area sovereign markets and global weaknesses, downside risks remain particularly acute. Renewed concerns about policy slippages in program countries or lack of commitment to continued support of program countries at the euro area level could amplify the shockwaves seen during the 2011 summer throughout the euro area with adverse repercussions regionally and globally. Although substantial amounts of capital were raised ahead of this summer’s stress tests, capital buffers remain low in a significant number of euro area financial institutions, which reduces their ability to cope with shocks. Funding could dry up, jeopardizing the functioning of the financial system, at a time when banks and sovereigns are facing major rollover requirements. Compounding the intra-euro area stresses, a further setback in global growth would also generate negative spillovers.

With growth momentum waning and financial tensions rising, policy adjustments are called for. The withdrawal of monetary support, or monetary tightening in the cyclically more advanced economies, will need to be paused or even reversed in cases where downside risks to inflation and growth persist. While the deteriorated state of public finances, and renewed market concerns over sovereign debt, leave no option but to strengthen fiscal positions, the slowdown in growth is calling for caution. Where pressures are most severe, the consolidation should continue to be front-loaded—intensifying market pressures is hardly an option. In other countries, where medium-term fiscal consolidation plans are credible or have been front-loaded, there may be room to allow automatic stabilizers to work fully to deal with growth surprises. Crisis management in the euro area needs to go beyond its current approach to secure success. Euro area leaders need to spell out and recommit to a common vision of how the

euro area is expected to function in the future. This is essential to anchor market expectations and dispel the prevailing uncertainty. Overall, a definite strengthening of fiscal and economic governance of the monetary union is needed. While strengthening national budgetary rules, countries will need to cede some control over their fiscal position to a central euro area body. Increased ex-ante fiscal risk sharing is likely to be necessary together with a common approach and backstop to the financial system of the euro area.

A number of actions to deal with the crisis should be undertaken urgently. Implementation of the July 21 EU summit decisions should be accelerated. More comprehensive actions toward restructuring and front-loaded strengthening of banks’ capital buffers are also needed, as uncertainties surrounding bank balance sheets continue to rattle investors. Ideally, capital should be raised through private solutions including cross-border consolidations. In the absence of these measures, supervisors will have to make the case either for injecting public funds into weak banks—which will be difficult in an environment of fiscal consolidation—or closing them down. Ending the intertwining of sovereign and bank balance sheets stresses ultimately requires a European Resolution Authority, backed by a common deposit guarantee and resolution fund. An escalation of the strains in euro area debt markets also poses risks for emerging Europe, considering its tight economic and financial linkages with advanced Europe together with fragilities stemming from the 2008/09 crisis. Policy makers will need to make headway with repairing public finances, including through strengthening fiscal frameworks to underwrite lasting fiscal discipline. Addressing high ratios of non-performing bank loans is another priority to improve conditions for new lending and reduce economic drag from overextended borrowers more generally.

Raising growth rates in slow growing countries would help address many of Europe’s pressing problems, not least lingering concerns about the longer-term sustainability of public finances. In the past decade, growth rates in GDP per capita have differed markedly among European countries, from zero in Italy and Portugal to more than 4 % in the best performers. To a large extent, growth differentials reflect convergence. However, a number of countries have grown less than their potential because of poor macroeconomic policies and barriers to growth. Heavily regulated goods and labor markets and inadequate institutions and macroeconomic policies have kept some countries less flexible, less competitive, and less integrated into the global economy than their better-performing peers, and this explains much of their inferior growth performance. Escaping low-growth traps is not easy, but the experience of the Netherlands and Sweden in the 1980s and 1990s demonstrates that it can be done. Reforms should be comprehensive, addressing both macroeconomic imbalances and structural problems, not only because both matter but also because reforms can be mutually reinforcing. Implementing reforms takes time and the rewards become visible only with some delay, but the long-term impact can be substantial.

The successful integration of emerging Europe has led to increasing spillovers between advanced and emerging Europe. Emerging Europe is now one of the most dynamic markets for advanced Europe’s exports; production chains have become highly integrated across borders; and western European banks have come to dominate emerging Europe’s banking systems. The growing interaction has benefited both regions, but it has also meant that shocks in one region increasingly affect the other, with spillovers progressively traveling both ways. Financial and trade spillovers interact, as shocks to financial flows from west to east are soon felt in trade flows. Spillovers may complicate economic policy making, but such challenges should not detract from the fundamental benefits of economic and financial integration.