Europe may follow Japan’s recession

High debt, low growth, and unemployment may become “the new normal in Europe”, according to Christine Lagarde, managing director of The International Monetary Fund (IMF). These words, together with Prime Minister David Cameron’s announcement that “red warning lights are once again flashing on the dashboard of the global economy” mean that 2015 could see a return to the global economy crisis of 2008.

The two warnings coincided with news on Monday 17^th November that Japan, the world’s third largest economy, had slipped into recession at the end of the third quarter following an annualised drop in Gross Domestic Product (GDP) of 1.6%. The projected GDP, going into the final quarter, was a rise of 2.1%. The contrasting fall means that clouds of caution have descended upon the world’s finance ministers.

The most alarming concern is that Japan had started to look like a country who could set the standard for economic recovery. The Japanese stock market was in ascent, and inflation, an idea that for decades had remained condemned as hope rather than reality, was back on the country’s agenda. Why then, has a country making its way down the road to economic recovery, suddenly taken a U-turn?

The irony behind the decline into recession is that Japan’s unorthodox approach to economics was seen as a small step towards recovery not just for the country itself, but for a Europe dotted with scars from 2008. The notion of fiscal belt-tightening and increases in tax, combined with the central bank loading money into the economy was expected to quell Japanese fears regarding recession. The question now, however, is whether these scars will ever fade, as Japan’s programme of fiscal discipline and monetary stimulus, its “grand economic experiment”, is failing.

David Cameron, and his fellow world leaders, will be hoping that the cautionary stance caused by the situation in Japan will blow over. If, in the worst case scenario, it descends into a storm reminiscent of the 2008 crisis, then we will be staring down the familiar barrel of discontent. The current crisis between Ukraine and Russia, combined with the rise of ISIS in The Middle East, and the desperate attempts to impede the progression of Ebola in Africa, mean that the light of recovery for a Europe plunged into a new recession would be a mere dot at the end of a tunnel cast into darkness by current world events.

It is the doubt surrounding the resolution of current world affairs that ensures the European Central Bank is sat on a pedestal of indecision. At a time where the majority of Europe’s economies are suffering the effects of matters abroad, the fundamental question at home is how to pursue further economic growth without running the risk of emulating Japan? Jacob Funk Kirkegaard, an economist at the Peterson Institute for International Economics in Washington, has warned that “Japan [has] show[n] that if you have longstanding economic stagnation, having an aggressive monetary policy and even sizable fiscal reform [does not] work without deep-rooted structural reform”, going on to say “the experience of Japan must be at the top of the minds of European leaders”.

The decline of Japan’s economy may ultimately prove to be a blessing in disguise for Europe’s leaders. They may now shy away from plans to follow in Japanese Prime Minister Shinzo Abe’s self-titled Abenomics. Although the European Central Bank recently said that it would be willing to take additional steps to spark recovery, such as lending more to banks and buying bonds backed by mortgages and other assets, critics have said a lack of aggression towards revival has resulted in a motionless economy.

The lack of progression has led Bart van Ark, chief economist for the Conference Board, to state that “Europe has the potential to become a second Japan in terms of significantly slowing demographics, and weak per capita income growth”.

Should this happen then the outcomes are bleak. A combination of world crises, and decline into European recession, would ensure the clouds of caution descend into a thunderstorm all too reminiscent of 2008. With recovery signs only appearing 6 years on, it could now be decades before Europe’s economy can safely reside under a banner of stability.

By Thomas Nugent