Two-Speed Recovery: US vs. EU

The August 2013 gross domestic product report by the US Bureau of Economic Analysis drew little attention, but it contained a fairly remarkable piece of data: Inflation-adjusted GDP per capita in the United States hit a new all-time high in the second quarter of 2013, the first time a new high had been reached since 2007. Real consumer spending has hit a new high, too, and auto sales are at levels not seen since before the financial crisis. Millions of Americans are still searching for work and suffering financial hardship, but on average, by the broadest measures of economic performance, America’s Great Recession is over.

Few nations across the Atlantic can say the same. The eurozone slipped back into recession in 2012 for the second time in four years, and remains in an economic state that can be accurately described as miserable. Real economic output among eurozone nations remains three percentage points below its 2008 peak. Eurozone unemployment sits near twelve percent in late 2013, higher than the US ever experienced at the peak of its recession. These problems are as deeply human as they are economic or political. Each percentage point rise in Europe’s unemployment rate has boosted its suicide rate by 0.79 percent, according to a study published in the medical journal the Lancet.

Determining why economies act the way they do is often elusive because it is so difficult to conduct controlled experiments. There are no laboratories, no test tubes, in which whole economies can be manipulated and studied. But the 2008 financial crisis provided economists with the next best thing: A crisis striking nearly everyone on the globe. This opened a window that allows us to see how different nations reacted to, and recovered from, a similar financial shock in real time.

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Why America’s economy has recovered while Europe remains stuck near recession is largely a factor of two forces: Europe by and large chose the path of fiscal austerity while America chose stimulus, and America also has control over its own currency, while member states under the euro currency do not. Most economic analyses of the last four years begin and end there, concluding that the dual force of fiscal contraction and monetary skittishness has unreasonably slowed Europe’s recovery and cost its economy dearly. Oxfam International estimates austerity across European governments could leave twenty-five million of its citizens in poverty by 2025.

But the situation is far more complex than can be explained by economic politics alone. Two other specific factors are also particularly persuasive in explaining the economic chasm between America and Europe: the deleveraging of household debt, and demographics.

Understanding the role of deleveraging in the current economic landscape begins with a brief look back at the aftermath of World War II, the crucial moment in the modern world’s relationship with debt.

The Great Depression of the 1930s left American policymakers bewildered and worried. When the war ended in 1945, a prevalent fear arose that the economy would slip right back into depression. In 1947, the Council of Economic Advisers warned President Truman of “a full-scale depression sometime in the next one to four years.”

Policy was needed to combat this risk. But with Europe and Asia devastated, exports couldn’t be relied on to fuel American growth. The country was on its own. The millions of soldiers demobilized from war would be turned into heavyweight consumers. Mortgage rules were relaxed, interest payments became tax deductible, and new lending programs made consumption more attractive.

Spending boomed after the war, fueled in great part by debt. Household debt grew sevenfold between 1949 and 1968, from $60 billion to more than $400 billion. Surging consumption led to an economy that was thriving and sustainable. While household debt rose in the 1950s and 1960s, so did the average American’s income—so much so that debt-to-income ratios rose only modestly through the 1970s.

The 1980s brought a new status quo. Debt continued to grow, but income growth languished and then plunged for most American households. The economy prospered tremendously during the 1980s and 1990s, but the majority of gains were concentrated in a small percentage of households. Most consumers saw little real income growth.

While average incomes stagnated, however, the average desire for material goods did not. With legitimately rich Americans raising the expectations and aspirations of their lower-income peers, this less fortunate sector of the economy, unwilling to cut back on consumption, had to rely on higher household debt to maintain household spending growth. Lending standards went from lax to absurd. Alan Greenspan, chairman of the Federal Reserve from 1987 to 2006, stood before Congress early in the last decade and noted that “children, dogs, cats, and moose are getting credit cards.” Household debt-to-income ratios were sixty-five percent in 1980, ninety percent by 2000, and more than one hundred and twenty percent by 2007, when they peaked and sent the economy into the Great Recession.

It may appear that nothing has changed, but America has actually spent the last six years diligently dealing with its debt bubble. Household debt has declined by nearly $1 trillion since 2008. As a percentage of GDP, household debt has shrunk from more than one hundred percent in 2009 to less than eighty-five percent in 2013. Most of this debt was wiped away through default, as borrowers who stood no chance of repaying mortgages for which they barely (if at all) qualified walked away from their homes. But Americans also found the will to repay chunks of debt. The personal savings rate surged from near zero percent in 2005 to more than seven percent by 2011. The number of Visa credit cards in circulation actually fell between 2009 and 2011, the first decline in history. Combine this retrenchment with mortgage refinancing at record-low interest rates, and the progress becomes nothing short of extraordinary: Household debt payments as a percentage of disposable income have plunged to the lowest level in more than thirty years. Our half-century addiction to consumer credit has come to a sudden and dramatic end.


Europe has enjoyed no such progress. Aggregate household debt to GDP among eurozone nations was higher in early 2013 than it was in 2008, before the credit crisis began. The lack of progress is widespread across the region. German and UK households saw a mild deleveraging from 2008 to 2011, but household debt-to-income ratios in France rose from seventy-five to eighty-three percent, in Italy from fifty-eight to sixty-five percent, in the Netherlands from two hundred and forty-nine to two hundred and sixty-six percent, and in Ireland from two hundred and nine to two hundred and twelve percent. European household debt to GDP has historically been well below that of the United States. Now we have traded places; European households are more indebted than Americans.

Why American households have deleveraged while European debt burdens continue to rise is largely due to fiscal and monetary policies. The economist John Maynard Keynes once discussed the “paradox of thrift,” a phrase that describes the process by which economies sink into despair when everyone—including consumers, businesses, and governments—attempts to save money at the same time. Fiscal policies in the United States—tax cuts for working families, extended unemployment benefits, and education grants to states—sidestepped this paradox by allowing the economy to grow modestly even while households deleveraged, as government consumption and investment picked up much of the slack.

European economies were by and large given no such assistance. This is partially due to monetary constraints. The United States borrows in its own currency, and the dollar is the world’s reserve currency, which provides extraordinary power to borrow large sums of money at low—indeed, negative—real interest rates. European nations, particularly those with small economies along the periphery, do not, and cannot. The borrowing capacity of governments has been restrained by risk-averse debt markets—to say nothing of risk-averse policymakers—preventing bold fiscal stimulus policies and leaving economies with interest rates well above the rate of nominal wage growth (which, in some cases, has been negative). Household debt deleveraging is extraordinarily difficult in this environment.

Unshackled from their excess debt burdens, American households have found room in their budgets to resume consumption growth. The numbers are staggering: American households will spend close to $400 billion less on debt payments this year than they would have if debt relative to income had remained at 2008 levels. That’s more income that can be devoted to consumption. Real household spending in America fell sharply in 2009, but rebounded quickly and is now more than five percent above levels seen before the financial crisis. Higher consumption leads to higher wages and greater levels of saving and investment. And since Americans are increasing spending with the lowest debt burden in decades, they are doing it in a safe, sustainable way.

European households, unable to deleverage, cannot benefit from a similar tailwind. Real household consumption in the eurozone was lower in 2012 than it was in 2008, according to Eurostat. There are hints of growth beginning to emerge in spots around the region, but the cycle European economies face is vicious: Too much debt leads to lower household spending, which leads to lower incomes, which leads to lower spending, which leads to lower incomes, which prevents the shedding of household debts. “Repeat until broke,” as the saying goes.

Without the kind of support from the government sector America has received, the cycle is maddeningly hard to break. Harvard economists Carmen Reinhart and Ken Rogoff looked at financial crises over eight centuries across sixty-six countries. Recoveries after a debt bubble, they found, take an average of seven years before the economy returns to its previous peak. Europe will likely push this average up.


If differing approaches to deleveraging is one explanation for the economic prospects of America and Europe, a second major distinction involves demography.

All economic progress is derived from a combination of productivity growth and population growth. Economists and business journalists tend to give more attention to the former, since studying the trajectory of a new technology is more thrilling than studying actuary tables. But a country’s reproductive habits can indeed dictate the direction of its economy.

The trend in global demographics is well known: it’s down. “In 1979, the world’s fertility rate was 6.0,” author Jonathan Last writes in his book What to Expect When No One’s Expecting. “Today, it’s 2.52.”

In some ways this represents monumental progress. As societies grow richer, they have fewer children; infant mortality declines and parents’ need to be cared for financially in old age diminishes.

But the preference for fewer children can backfire. Without a boost from immigration, a birthrate below two per woman sets a population on a path of decline. And as goes fertility, so goes the economy. “There is no precedent in human history for economic growth on declining human capital,” writes author Mark Steyn.

United States citizens of working age—those between ages fifteen and sixty-four—equal sixty-six percent of the country’s total population this year. That is set to decline to sixty-four percent by 2020, sixty-one by 2030, and sixty by 2050, according to the US Census Bureau’s projections.

The long-term graying in Europe is more severe. Sixty-seven percent of the region is currently of working age. That will decline to sixty-three percent by 2030, and plunge to fifty-eight percent by 2050—nine percentage points lower than today. The situation is particularly grim in a nation like Spain, where the working-age population will fall from sixty-seven percent today to fifty-five percent in 2050.

These are, however, long-term trends, with the harm they produce to be faced decades in the future and reliant on projections prone to significant error. But demographics also help explain the real economic chasm between Europe and the United States in recent years.

Key here is the cohort of those between the ages of thirty and forty-four. This group, we know from consumption statistics, is the engine of consumption-based economies. For one thing, those in this age group buy the most homes. The median age of a homebuyer is thirty-nine in the United States, according to the National Association of Realtors, and between thirty-four and thirty-six throughout Europe.

They also buy a lot of cars. Americans in their thirties and forties spend more on vehicles than any other age group, according to the US Bureau of Labor Statistics.

A quick scan of the Census Bureau’s list of spending by age group shows that consumers in their thirties and forties lead in several other categories as well. Per person, they spend the most on food, housing services, furniture, apparel, footwear, and entertainment. They are an entrepreneurial bunch as well: According to the Kauffman Foundation, the median age of a company founder when beginning his or her current business is forty. They are, quite literally, the most vital cohort in modern economies.

But something important—and different—has happened to this prime-age group in the US and Europe in recent years. Since the global economy began to slow in 2007, the number of European citizens between the ages of thirty and forty-four has declined by 2.6 million, or nearly two percent. In America, the cohort has increased by a quarter million—not a large gain, but hardly the gaping decline seen across the Atlantic. This divergence in prime-age consumers alone explains a meaningful share of the difference between European and American consumer spending trends over the last several years.

To understand how this demographic quirk occurred, we again need once again to go back to the end of the Second World War. Both America and Europe enjoyed a baby boom after the war ended. America went from having 2.6 million babies in 1940 to 4.3 million by 1960. But the boom peaked and then fizzled. By 1975, America was back down to 3.1 million births per year. Europe’s live-birth rate fell from nearly eight million in 1961 to six million by 1980.

But America’s “baby bust” was temporary. Its birth rate soon swelled to back above four million—nearly as many American babies were born in 2005 as were during the peak of the baby boom in the 1960s. Europe can’t say the same. In 2011, the number of live births in Europe was just above five million, one-third below 1960s levels, according to Eurostat.

America’s rising birth rate that began in the 1970s—a second “baby boom”—means its ranks of citizens aged thirty to forty-four will continue to grow. Indeed, the Census Bureau projects the number of Americans in this cohort will rise by nearly five million from 2013 to 2020. Europe’s falling birth rate over the last four decades delivers the opposite fate: the number of Europeans of the same age is projected to decline by 1.3 million by 2020. If “demographics are destiny,” the verdict is clear: America has a light tailwind, Europe a stiff headwind.


Part policy, part culture, and part demographic fate, the economic divergence between American and Europe is striking. One side of the Atlantic has managed a fairly smooth recovery; the other remains stuck in neutral.

All policymakers, but particularly those in Europe, must act with a greater sense of urgency. The longer a recovery takes to complete, the deeper the scars. Till von Wachter of Columbia University has shown that losing a job during the worst economic downturns can reduce life expectancy by a year and a half. According to Yale economist Lisa Kahn, Americans entering the labor market during poor economic times earned seven percent less than those graduating into a strong economy. A full seventeen years after graduation, Kahn found those who began their careers during a weak economy still earned measurably less than those who began their careers in a strong economy, adjusting for age and inflation. This is the dangerous legacy global economies leave their youth: Those who step into a world of high unemployment may never be able to shake off the anchor of stagnation. America has to worry about the Great Recession leaving a mark for years. Europe must consider the possibility of scars that last for a generation.

Economic history makes clear that economies adapt, and often the seeds of booms are planted in busts. Five years ago, when dire predictions were arising from the “dependence on foreign oil,” no one foresaw America’s current energy boom. Even fewer were confident that its consumers could shed debt as quickly and effectively as they have. Many of the world’s great tragedies, from major wars to devastating natural disasters, were followed by booms of prosperity. Economists spend so much effort analyzing recessions that they often underestimate the odds of something good happening.

But for now, the Great Recession lingers. There are several questions to ponder: Are European voters sufficiently frustrated to demand a new direction of economic policy—away from austerity and toward growth? Will Europe’s central bankers attempt to stimulate the region, risking future inflation for the prospect of short-term economic gain? Will families in both America and Europe begin a new baby boom, as they did after the Second World War? Will a new recession strike, kicking global economies while they’re still weak? These questions will determine where we head next, yet we can’t answer them with any accuracy. Economics is a field strewn with unknowable unknowns.

But the lessons we have learned watching countries respond to the Great Recession are important. Two economies on opposite sides of the Atlantic reacted to the crisis with different approaches, and both are now on different trajectories: America toward growth, Europe toward stagnation. There will be more recessions in the future. These lessons should not be forgotten.

Morgan Housel is an economic analyst in Washington.

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