Industrial production has been falling in most European countries, driven by sluggish internal demand, high energy costs, and competition from the United States and China. The Wall Street Journal wrote in January that Europe’s growth engine is broken. Eurostat data released last month shows that industrial production fell by 2.2% in the eurozone and 1.7% in the European Union over the prior year. Germany, France, Italy, and Spain (Europe’s four largest economies) all recorded a year-on-year drop in the production of capital goods and consumer durables. It’s not all bad though; some of the smaller economies like Denmark, Greece, and Finland saw significant growth. Denmark had the fastest industrial growth in Europe – up almost 20% over the twelve-month period driven by its booming pharmaceutical industry, which has produced popular weight loss drugs and an mpox vaccine. The former president of the ECB,

Mario Draghi wrote in a report last month that the European Union today faces an existential challenge, and if it doesn't change, it will be condemned to a slow agony. He wrote that Real disposable income per capita has grown almost twice as much in the United States as in Europe since 2000, and, as things stand, there's no reason for this downward slide to stop. Germany – which has been a powerhouse of manufacturing in Europe for decades – has seen its output trend downwards since 2017, and Bloomberg writes that its days as an industrial superpower might be coming to an end. Since its peak, German industrial production has contracted by 14%, and it is now back to a level last seen in 2006 (if we exclude the sharp decline seen globally during the pandemic). This manufacturing downshift can be seen when factories are shuttered or firms reduce headcount, but it also shows up more subtly

when firms scale back their expansion and investment plans or decide to grow their operations in other parts of the world. Last week, Volkswagen – which is Germany's biggest employer - announced plans to close at least three factories, eliminate thousands of jobs, and slash wages for tens of thousands of German workers. This would be the first time in the company’s history that they have closed a factory in their home country, and the planned salary cuts could affect as many as 140,000 German workers. It could be argued that Volkswagen can be seen as a symbol of Europe’s battle for industrial relevance as it struggles to compete with foreign rivals, balance the demands of shareholders, unions, and government, deals with high energy costs, and grapples with an expensive transition to greener technology that its end customers are not necessarily demanding. From the launch of the Euro in 1999 through to the start of the pandemic, euro area exporters – and German firms in particular – benefited from

strong growth in China, which fueled demand for European capital goods. Over the same period, Europe switched from being self-sufficient in energy production to becoming the largest importer of natural gas in the world. Russia was the cheapest supplier, and the EU relied on it for 41% of its natural gas needs. The Economist wrote – when discussing Germany’s problems “A national business model built in part on cheap energy from one autocracy and abundant demand from another autocracy faces a severe test”. Since the credit crunch, US stock prices have hugely outperformed British and European stocks, and some of this is because European stocks are a lot cheaper on a price-to-earnings ratio basis – but – that is no excuse - US companies have seen earnings per share grow 290 percent since 2010 when European earnings only grew 60 percent over the same period. So, is industry destined to die in Europe and should Europe just

pivot to tourism and settle on becoming the world's museum, as some have suggested? Sometimes, it can be hard to find time to learn new things, but today’s sponsor Brilliant.org makes it easy to learn anywhere, right on your phone—with quick, fun lessons you can do whenever you have time. Whether you’re diving into a new topic or doing a quick practice session, you can level up on the go in just minutes. Brilliant’s comprehensive range of math courses is built for learners of any level, whether you want to brush up on fundamentals or challenge yourself with advanced concepts. Their problem-solving approach to learning not only helps you build real knowledge on specific topics but also helps you to become a better thinker. Brilliant is perfect for learners of all levels who want to start or continue learning math, programming, data analysis, or AI, with a full suite of content

for beginners through to experts. I'm told it's six times more effective learning with an interactive app than just watching a lecture. With Brilliant, you learn by trying things out for yourself, which is what makes learning with Brilliant so powerful. To try everything Brilliant has to offer for free for a full 30 days, click on the link in my description. You'll also get 20% off an annual premium subscription. According to Mario Draghi's report, which is one of the best pieces I could find on the problems facing Europe, high energy prices are a real headwind for European manufacturing. Natural gas prices are three to five times higher in Europe than they are in the United States, and electricity prices, specifically those for industrial sectors, are currently two to three times those in the US and China. Now, European energy prices have always been higher, but this issue has worsened over time.

In 2020, renewables overtook fossil fuels to become the leading source of power in Europe for the first time ever. But wind and solar power are incapable of generating enough power to account for 100 percent of demand year-round, even in the most favorable climate conditions. According to Draghi, the phaseout of nuclear power in countries like Spain and Germany, who have set national targets for winding down their existing nuclear fleets, increases the gap between consumer demand and the electricity supply that can be generated by renewable sources. The way power is priced in Europe is complex; they use a marginal model, which means that if a mix of sources is used, the price paid is set at the price of the most expensive fuel required to meet projected demand. So even if solar power is cheap – but some of the energy needed is natural gas – which is expensive in Europe – all suppliers end up getting paid the price

of natural gas. The model is set up this way to allow utilities to recover investments they made by installing new sources of energy on the grid. In situations where all of the demand can be met with wind, solar, and nuclear, which have low generation costs, the price of power can be very low or even negative — as happened in spring 2020, when electricity demand was low and renewable energy production was high. Countries like Spain, who generate most of their power from renewables, have complained about the way this pricing system works to the European Commission – they might be getting 95% of their power from solar – but if the remaining 5% was natural gas – they have to pay up as if the entire fuel supply had been natural gas. The European Commission has rejected their appeal, saying that other systems like a pay-as-bid approach have been analyzed and actually led to higher energy prices in places where they’ve been implemented.

Now, I haven’t seen any analysis of this, but it does seem quite surprising. One issue mentioned in Mario Draghi’s report is that marginal price-setters are often fossil fuel sources who are charged a carbon tax which is embedded in the price that they charge. This higher price then boosts what is paid to the renewable energy producers in the mix. According to the report, carbon costs accounted for around 10% of the EU industrial retail electricity price in 2023. An Economist piece on renewables and the European energy market makes the point that at times European energy is very cheap. They argue that firms and regulators are simply not making the most of this and that there are three ways a more efficient market could be established: 1) sending energy to areas where there is no surplus; 2) shifting demand to hours when energy is plentiful, and 3) storing energy as electricity, fuel or heat. The problem with those solutions is that

sending electricity to places where it’s needed involves expensive grid upgrades. Storage involves expensive battery packs – or building out hydrogen storage systems or systems where excess solar energy is used to pump water up a hill, and that water can be used later for hydro power when there is not enough solar energy – but once again, all of this is expensive – and all of these solutions can be held up for years in planning. It is slightly disingenuous to claim that the renewables are cheap – if they only provide reliable power after a bunch of really expensive upgrades are made. I by no means claim to be an expert on this topic – but I do find it really interesting and have read up quite a bit on it. I can find lots of articles telling me how cheap renewable energy is, but despite all of this cheap energy – power is so expensive in Europe that factories are shutting down. I don’t really see any Enron-type middleman

getting rich in Europe by ripping everyone off – but the money must be going somewhere. It mostly appears that a lot of new sources have been tacked onto the existing electrical grid, and they don’t really work that well together yet – and the solutions that will get everything working will both be expensive and take time to implement. I aim to learn more about this, as it seems to me that energy is a big problem that will need to be solved in the coming years. The Economist's other solution of shifting demand to hours when energy is plentiful and cheap (using things like smart meters) may work for certain types of users – your electric car (for example) could be set up to charge itself in the middle of the day while solar energy is cheap and you are at work – but that still doesn’t work for a factory that needs to be running twenty-four hours a day. Energy is obviously a very complex problem – more complicated than Will Smith’s marriage… – but

finding a solution does need to be prioritized in Europe. The chief economist of Berenberg, a private bank, told the economist last year that, with energy prices likely to stay high for a while, 2-3% of Germany’s industrial companies that use energy-intensive processes will likely relocate abroad. I made a video about a year ago on how China overtook Japan to become the largest car exporter in the world. China's exports have been stepping up as its economy has slowed – as its leader’s solution to a drop in domestic demand has been to manufacture the same amount of goods as when the economy was booming and export the surplus. As a result, the European Commission imposed new tariffs of up to 35 percent on Chinese EVs on top of the existing 10 percent duty. The automotive sector employs thirteen million people in Europe and makes up 7% of total employment in the region,

so it’s no surprise to see the EU pushing back against massive, subsidized imports. The export-led growth model is an economic strategy pioneered by Germany and Japan in the post-war period that aimed to grow productive capacity by focusing on foreign – rather than domestic markets. It rose to prominence in the late 1970s – largely driven by its success in Japan and became part of a new consensus among economists about the benefits of economic openness. One of the problems today is that every economy around the world seems to plan on growth through exports – with no one planning on running a trade deficit – and that simply can’t work – If everyone is exporting, someone has to be importing. The Economist Thomas Palley argues that there are reasons to believe that the export-led growth model stopped working after the 2008 financial crisis because of changed conditions in both developing and developed economies. High debt in the United States, fiscal austerity in

Europe and supply-side stimulus in emerging markets led to a global demand shortage. He argues that going forward there needs to be a shift – in most economies - toward domestic demand–led growth while only aiming to export enough to pay for imported goods that are not produced domestically. Essentially, a move towards more balanced trade. No matter who wins in the upcoming US election – trade can be expected to be a huge political issue going forward in the United States and while the Democrats and Republicans may offer different solutions, protectionism, tariffs, and subsidies do appear to be in the cards. While American productivity appears to have grown during the pandemic, the same thing did not happen in Europe. The FT reported this week that German business executives are now warning that high levels of sick leave are damaging their competitiveness and compounding the country’s economic woes. A study found that were it not for the country’s

above-average number of sick days. The German economy would have grown by half a percent last year, rather than shrinking 0.3 percent. Lower European productivity is, however, not just explained by extra sick days. According to Mario Draghi, the productivity gap between the EU and the United States over the last twenty-five years is largely explained by the tech sector. Europe mostly missed out on the digital revolution and the productivity gains that it brought. He says that the problem is not that Europe lacks ideas or ambition, but innovation is blocked at the next stage. It is not translated into commercialization, and innovative firms that want to scale up are hindered by inconsistent and restrictive regulations. Many European entrepreneurs, he says, prefer to seek financing from American venture capitalists and scale up in the American market. There are large sections in his report on computing and AI and semiconductors – unfortunately, these topics all circle back to the high European energy costs, which represent

a disadvantage for EU-based providers. According to Mario Draghi, the European economy has fallen behind the United States, and China is rapidly catching up. Real disposable income per capita has grown almost twice as much in the United States as in Europe since 2000, and he says that as things stand, there's no reason for this downward slide to stop. He says that due to the ageing European workforce, by 2040 the population will start to lose 2 million working people per year, which will mask the effects of lower growth. But without growth, Europe will not be able to finance its social model and will have to scale back some, if not all, of its ambitions. An IMF blog post from earlier this year asked if Germany (the manufacturing center of Europe) was irreparably broken? They highlight that critics say that strong growth in previous decades was based on importing cheap Russian gas,

which powered Germany’s export industries. With this cheap gas no longer available, the German manufacturing model stopped working. They point out that after a big spike in 2022, wholesale gas prices fell back to 2018 levels – they say that it was not the loss of Russian gas - but that the post-pandemic rebalancing of global demand from manufactured goods – which Germany specializes in - towards services was unfavorable for Germany’s economy. They argue that concerns for the longer-term future of German industry are exaggerated. While energy-intensive industries like chemicals, metals, and paper manufacturing have contracted, they only make up 4% of the German economy. Automobile production, on the other hand, rose 11 percent last year. They highlight that “manufacturing value-added” remained steady even as industrial production fell because manufacturers adapted to the energy crisis and supply-chain disruptions by shifting into higher value-added products.

that use fewer intermediate inputs. They say that the biggest problems for Germany are a projected decline in Germany's working-age population – which this chart shows is much worse than is expected in Japan, the rest of the EU, and the UK. They argue that German productivity has been dragged down by inadequate investment in public infrastructure, where Germany is near the bottom of advanced economies in terms of public investment. This is mostly driven by the German aversion to debt. While borrowing for the sake of borrowing makes no sense – borrowing to pay for necessary infrastructure that will boost the nation's productivity does make sense. Productivity could also be enhanced by cutting red tape, they say. Apparently, the German economy is bogged down with excess regulation. They give the example that it takes 120 days to obtain a business license in Germany, which is more than double the OECD average. While news of Volkswagen's factory closures led

to headlines of European industrial decline. The problems at Volkswagen can be explained as much by its own corporate governance issues and a botched transition to EV manufacturing than the fact that it is a European firm. Volkswagen's emissions cheating scandal in 2015 tarnished its reputation with customers, regulators, and investors. Its focus on manufacturing expensive SUVs and exporting to China has not worked out. I would argue that almost every problem with Volkswagen is summed up with its new electric bus. Now look – I’m no Chip Foose – and I’m really no graphic designer either– I don’t think many graphic designers use PowerPoint, but I think I could fix a few of the problems with the Volkswagen ID Bus. Firstly, they got the front wrong – it needs to look like the original one… We’ll need a bigger logo next, then they got the top wrong – we need all those windows back… We need to get the wheels right.

next, and this doesn’t make a ton of sense. If you are taking family trips – it should probably be a hybrid… And of course – this is the worst part… Seventy thousand dollars… It’s a minibus – not an s class… If anyone at Volkswagen is watching – I’m happy to help out – this is turning into a bit of a budget version of mighty car mods… Don’t criticize the panel gaps either – I did this in PowerPoint – and there are people out there Cybertrucks – this looks just fine – we can put an ipad on the dashboard – people seem to love that… Anyhow… This is not a car design channel – I’m just trying to help out… Nico Palesch at Oxford Economics argues that the decline in European industrial output in recent years is more of an industrial recession than deindustrialization. He says that Europe’s shrinking share of global industrial output is more driven

by increased output from Asia than by decreased competitiveness in Europe. He points out that the industrial share of GDP only declined slightly in 2022 and 2023, indicating that the current industrial troubles should be seen within the context of a broadly weak economy, and this is not deindustrialization. He says that some industries can be expected to decline, but this decline will be offset by the rise of other industries. He points out that Europe’s strengths lie in highly complex, specialized areas of manufacturing, and these areas require a highly educated workforce (which Europe has), they benefit from network effects, institutional knowledge, and the cumulative impact of decades of investment in intellectual property, patents, and physical capital. There are further barriers to entry too - in the form of research costs and building trust amongst potential customers. Mechanical engineering, electronics, and pharmaceuticals are examples of sectors where Europe competes strongly. Companies like ASML who make the machines needed to produce

semiconductors; Novo Nordisk, who makes the blockbuster drug Ozempic – that we mentioned earlier; and Airbus, the airplane manufacturer, are the types of high-skill, high-specialization businesses that are thriving in Europe. These sectors are still growing as a share of total industry and economic activity. Europe’s ageing workforce, according to Palesch – puts in place an incentive for greater factory automation, which he points out Germany is a leader in. Certain industries, he says, are at risk like textiles and clothing, paper manufacturing, refining, plastics, metals, and chemicals. The green push in Europe combined with high energy prices means that energy-intensive industries like reducing iron ore to make steel, heating limestone to produce cement, and using steam to crack hydrocarbons into their component molecules will be a struggle. On top of that, the chemical processes themselves give off lots of additional CO2. Cutting all of those emissions appears

to be prohibitively expensive – given today’s technologies. The problem is that shutting down those industries in Europe and importing steel, cement, and petrochemicals just means that the pollution occurs in other parts of the world – where these processes are often done in a dirtier manner than they are done in Europe. It makes neither environmental nor economic sense. The chemicals industry faces the biggest challenge as it is extremely reliant on hydrocarbons both for energy and because thousands of necessary products are derived from crude oil. One 42-gallon barrel of crude oil creates just under twenty gallons of gasoline, and the rest (more than half) is used to make everything from ink to antihistamines to fabrics, detergents, paints – the list goes on… Part of the case made to European voters who were skeptical of the need for a green transition was that going green would do more

than just fend off climate change. It would make Europe less dependent on Russian gas and create lots of new green tech jobs. Critics today argue that meeting the new environmental targets with shiploads of Chinese solar panels – which were produced using cheap Chinese coal – has only served to move pollution to the other side of the world and change the autocratic regime Europeans have to depend on while crushing employment. Labor unions in the UK are arguing that green policies are hollowing out working-class communities and that the government needs to stop decarbonization through deindustrialization. Going back to Mario Draghi’s report – which I have linked to in the video description – he highlights that European companies face electricity prices that are two to three times higher than those in America, and natural-gas prices are four to five times higher. He says that Europe’s energy market has to be quickly reformed so that end-users can see the benefits of clean energy in their bills.

Industrial energy prices in the EU are impacted by taxes, levies, carbon fees, and other charges, which, when combined, account for a substantial portion of the final energy cost, which is substantially higher than in other global regions. I mostly agree with Oxford Economics that Europe is not deindustrializing – some industries are suffering (in particular, the most energy-intensive ones), but others are growing. For all of the talk of German deindustrialization, manufacturing there still makes up almost 20 percent of the economy – which is about twice the level of the US. With China stimulating its economy and pumping out more exports than ever before, while importing next to nothing, and the US moving in a protectionist direction, the export-driven growth model may have reached the end of the road, and economies may need to restructure towards domestic demand-led growth, aiming to balance imports and exports such that enough is exported to pay for goods that are not produced domestically. This might impact emerging markets.

much more than Europe, as they may not be able to rely on the United States to absorb their excess production in the way they could in the past. There are lots of challenges ahead for Europe – as there are for the rest of the world too, but Europe has a highly educated workforce capable of high-tech production and innovation. Unlike some of the critics, I don’t expect the continent to turn into the world's museum or become some sort of green energy version of Easter Island where they keep buying solar panels from China until the whole economy grinds to a halt. If you disagree – do let me know in the comments section. If you enjoyed this video, you should watch the one on why Europe is worried about Chinese EV’s next. Don’t forget to check out our sponsor Brilliant using the link in the description. Have a great day and talk to you again soon, bye.

Deindustrialization in Europe?

Patrick Boyle is a hedge fund manager, a university professor and a former investment banker. 

This channel is all about quantitative finance. By subscribing you will see videos explaining what is happening in markets right now, you will learn about financial derivatives, corporate finance and how traders use quantitative tools like statistics. You will see interviews with some of the most interesting people in the financial industry.  In addition, you will see some longer form documentaries on the history of financial markets.

To contact Patrick go to the website http://onfinance.org

DISCLAIMER:
This channel is not affiliated with any financial institution. The videos on this channel are for entertainment purposes only and do not constitute financial advice. Those seeking investment advice should seek out a registered professional. Patrick is not responsible for investment actions taken by viewers and his content should not be used as a basis for investment.