Trade deals could be great opportunity in eurozone

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Sources: Mountaintop Economics & Research Inc.,, Focus Economics

The European economy looks like it will recover its footing in the second half of 2018 after a sluggish start to the year.

On net, the growth rates for developed European economies will lag the gains experienced by the less-developed countries in Eastern Europe, but they will still be in line with the longer-term average of the past 10 years.

The eurozone economy is likely past the peak in the current business cycle, and there will not be any bump from lower taxes like there was in the United States. Nevertheless, the current recovery phase should extend through at least 2020. Growth in real GDP in the eurozone accelerated to about 2.5% in 2017, and my latest forecast calls for a moderate deceleration to just over 2% in both 2018 and 2019.

The growth rates in the Eastern Europe economies will remain robust in comparison to those of the more developed economies to the west. Labor markets are tight, interest rates are low, and investment and development funds from the European Union continue to flow into these countries. Several Eastern European countries are experiencing labor shortages, and this is impeding their ability to achieve even stronger rates of growth.

This region relies heavily on demand from the eurozone so any change in the activity levels in the EU will have a large impact on Eastern Europe. Under current conditions, the forecast is for average growth in Eastern Europe to reach 4% this year, and it will stay above 3% in 2019.

The dominant factor in the outlook for the UK is the Brexit negotiations. There is a great deal at stake economically for the UK if the negotiations break down, but in my opinion, there was never a clearly articulated economic reason to vote for Brexit in the first place. It was about politics and ideology, not economics. As of now, I expect the UK to leave the EU but maintain border-free access to the single market of goods for the next few years. All of this means that economic growth will be just over 1% in 2018 and 2019.

One problem specific to the European plastics industry is overcapacity. Demand for plastics products has increased steadily during the past few years, but investment in new plants and equipment has risen faster. A similar scenario is occurring in the US, and it is starting to show up in the monthly data.

In both the US and Europe, both the total output of plastics products and the total amount of factory capacity to manufacture plastics products remain in a gradual trend upward. But the capacity utilisation rates — the percentage of the total capacity that is actually being used — is trending down. New investment has made the plastics industry more efficient; therefore, profit margins have been sustainable even at the lower utilisation rates. But if demand for plastics products does not accelerate, then investment in new plants and equipment will soon decline.

My outlook for the European economy is based on expectations for only a small disruption to trade in the near-term and an ultimate reduction in overall tariffs on US products going forward. Without question, the dominant economic story in the US at the present time is the uncertainty stemming from the trade policy situation. And it is easy, perhaps even unavoidable, to get caught up in all of the negative rhetoric. A disproportionate fear of loss is a hard-wired adaptation that cannot be completely eliminated from the human brain.

But my innate biases notwithstanding, I still believe the outcome with the highest probability is the one in which the US eventually signs beneficial trade deals with all of our major trading partners, including the European Union. Under this scenario, the next deal signed will be with Canada. This will be followed by Great Britain, and then the EU. China will take more time, but even here I believe it is most likely that a deal will eventually get signed.

I fully acknowledge the chance this forecast may be wrong, so it is not without risk. But the risk is not all on the downside. There is also the upside risk that may be realised if the trade disputes are resolved in a way that results in increased trade and overall economic activity. Once all of this is behind us, the global economy could very well get another boost of optimism and investment.

The Trump administration has eschewed the long-entrenched approach to US foreign trade policy that lowered uncertainty in the near-term, but which came at the cost of a more beneficial long-term outcome. It appears the Trump team recognises that none of our trading partners will willingly give up an advantage until forced to do so. The entirely predictable early responses to Trump's opening positions have been a lot of grumbling and an increase in lobbying efforts. But the global economy has not stopped and neither have the negotiations. Every country that aspires to continued economic growth wants to conduct business with the United States.

The EU will continue to be the largest trading partner for the US, so the strong economic fundamentals that will prevail on both sides of the Atlantic for at least the next two years should continue to be a mutually beneficial tailwind for the foreseeable future. I will not offer a prediction of the politically based outcomes, but from an economics perspective, all sides have a chance for gains with an agreement to the lower trade barriers.


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