In 2018, expect the euro area economy to put on the brakes – but not for the reason you may think

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV.com PLC.

Workforce ageing and poor management of the demographic change is slowing down growth in the euro zone's largest economy, Germany. [Shutterstock]

The euro area economy has at last started to begin recovering convincingly from the past decade’s two recessions. But two big factors will moderate growth in 2018, writes Ilaria Maselli, citing the ageing workforce in Germany as being of particular concern.

Ilaria Maselli is a Senior Economist at The Conference Board, a global business research organisation.

In 2017, Europe experienced political uncertainty on steroids.

Just to scratch the surface, the year brought hung parliaments in the Netherlands and Germany. A rise of Euroscepticism and populism, like in France where the Front National of Marine Le Pen earned 7.7 million votes in the first round of the Presidential elections in April. And surprise elections with uncertain results like in the UK where Theresa May was confirmed as Premier with a thinner majority than what she had before.

Considering all of the turmoil and ambiguity, it made sense to expect a possible slowdown in economic growth. But in another blow to conventional wisdom, recent data shows the economy has been expanding.

In the third quarter of 2017, output growth in the euro area clocked in at 2.6%; at that time last year, growth stood at 1.7%. For the most part, the euro area economy has at last started to begin recovering convincingly from the past decade’s two recessions. All components of growth contribute to this robust recovery. With consumers playing the leading role, internal demand and imports have enjoyed healthy lifts. Companies have once again started exporting with vigor. And private investment and public expenditure also closed the quarter with a positive sign.

But still, this economy stands far from a proverbial bed of roses. While political uncertainty shows no signs of moderating growth, expect two big factors to start doing just that later in 2018. Talent shortages and capital misallocation will both constrain the economy’s capacity to expand.

First, finding and retaining talent has – and will – become more difficult with unemployment decreasing and new vacancies opening. Wait – weren’t the robots coming to take Europeans’ jobs? No. Rather than take Europeans’ jobs, robots are changing them dramatically. The mismatch between worker skills and demands of the new digital economy is already a reality now in many countries. Workforce ageing and poor management of the demographic change inside companies do not help. And this holds especially true for Europe’s engine of growth and fastest ageing country: Germany.

Second, capital represents another constraint to sustaining growth in the euro area. Among the factors at play, traditional capacity utilisation in manufacturing is rapidly approaching the peak reached before the global financial crisis.

Moreover, in recent years the highly accommodative monetary policy by the European Central Bank has caused alarming distortion in the allocation of capital. A good deal of liquidity found it way into the bond market and, just recently, into the equity market. Meanwhile, goods producers waited for long before they started investing again. Only one year ago, in 2016, less than half of EU firms classified their machinery and equipment as state of the art, according to a European Investment Bank survey. And just 14% said classified their investment activities as too low, with the hope of ensuring the future success of their businesses.

Capex investment has improved substantially since then. However, the very low interest rates for a prolonged period allowed many less productive companies – some on life support – to survive. The misallocation of capital has slowed the process of creative destruction that characterises innovation, productivity, and sustained growth.

While there will be no shortage of political challenges, domestic and international, that could derail economic recovery in 2018, the bigger threat may be of a purely economic nature: our failure to strengthen the potential of Europe’s economy through relieving today’s talent shortages and accelerating in technology and innovation.