IN HIS opening salvo ahead of this week’s EU finance ministers’ meeting, Gordon Brown rightly criticised the lack of demand in Europe as a more important imbalance in the world economy than the much-maligned US trade deficit. But, just as the Chancellor and other leading policymakers have begun to focus on the eurozone as the source of the world’s worst economic problems, there are signs that conditions in Europe may finally be on the mend.
While most of the recent statistics from the eurozone are still bleak by international standards — for example, the 2.4 per cent annualised GDP growth and the 2 per cent growth in consumption during the first half of 2004 — they have not been as weak as expected. More importantly, France and several other countries have been doing better than the eurozone as a whole.
Consumption and investment are growing decently in France and Spain, and are also picking up in Italy. Only in Germany is domestic demand still completely moribund.
We must ask whether the above-average growth in large parts of Europe is a random blip or whether the improvement has some stronger underpinnings. I have long had a sceptical bias about the economic outlook for Europe, largely because the euro still seems unsustainably high. But I can now see at least four plausible reasons for a strengthening of consumer demand — especially in southern Europe and France, which is likely to be the main engine of growth for the eurozone economy.
First is the gradual abandonment of the Stability Pact and the move to stimulative tax and spending policies — as President Chirac has tried to shore up his domestic popularity and win the acquiescence of increasingly belligerent trade unions for public sector reform. While the French Government’s concessions to economic populism — on public-sector salaries and pensions, employment subsidies and through hikes in the minimum wage — may damage the country’s long-term economic prospects, they are contributing a substantial Keynesian stimulus to consumer demand.
A second stimulus to European consumption has been the housing market. While economists and policymakers have been debating the benefits and dangers of the property booms in Britain, Australia and the US, property prices in much of southern Europe have taken off.
This is especially true of the Mediterranean region, where British buyers have been snapping up holiday properties and retirement homes. British property purchases in France are estimated to have been worth €8 billion (£5.5 billion) in each of the past two years. This capital inflow represents a significant injection of spending power, equivalent to 3 per cent of France’s annual consumer expenditure.
Big gains in house prices have now spread to the whole of France and Spain and much of Italy. According to The Economist’s quarterly international house price index, property inflation in Britain (13.8 per cent) has been overshadowed by the rates in Spain (17.2 per cent) and France (14.5 per cent), with Italy (10.8 per cent) only slightly behind.
Another magic ingredient in the US and British consumption miracles has been the deregulation of mortgage lending. This allowed the rise in property prices to expand consumer balance sheets and finance consumer demand.
Intensified competition, along with some tentative moves towards mortgage deregulation, have made European banks more aggressive lenders and have started to change the attitudes of borrowers and regulators. French and Spanish homeowners are taking larger mortgages, reducing their deposits and gingerly remortgaging to extract some of their housing equity to turn it into consumption. Even in Italy — which traditionally has had the world’s highest savings ratio, because middle-class households spend years accumulating enough cash to buy their homes outright — large mortgage borrowing is becoming much more prevalent in financing home ownership.
A third force that seems to be pulling European consumption out of the doldrums is a version of what is described in the US as “the Wal-Mart effect”. Intensified competition among large retailers is opening up many high-priced consumer markets to Asian, especially Chinese, goods. Just as high unemployment and job insecurity have made European consumers more price sensitive, the soaring euro has encouraged aggressive retailers such as Carrefour, Aldi and Ikea to turn to China for cheaper supplies.
This globalisation of retail supplies, which occurred ten or 20 years ago in the US and Britain, is transforming the ability and willingness of European consumers to buy big ticket consumer goods. The impact is visible at any Carrefour or Géant in France. A few years ago almost all of their TVs and washing machines were made — or at least branded as being so — by European manufacturers such as Thomson or Philips. Today these appliances are largely own-label or Chinese, and are frequently selling for half the old price or below.
This import growth is changing Europe’s industrial and social structure, putting many mass-production manufacturers out of business and their workers out of jobs. Europe will have to adapt by creating employment in new industries — as has occurred in Britain and the US — and former industrial workers will have to accept a good deal of dislocation.
A final reason to feel greater optimism about Europe’s economic prospects is the effect of China’s economic boom. European companies have, surprisingly, proved more successful, adaptable and fast-moving than their US-based rivals in China. At the micro-level there are many examples of European companies gaining dominant positions in Chinese markets over their US competitors: Volkswagen v GM; Philips and Siemens v GE and Westinghouse; Nokia and Ericsson v Motorola; Airbus v Boeing.
More significantly, such anecdotal evidence of European success is borne out by the macroeconomic statistics. According to Chinese statistics, imports from Europe in the past 12 months have been more than double imports from the US ($80 billion v $40 billion). Europe’s exports to China have grown by 31 per cent in the past 12 months, while US exports grew by 27 per cent — despite the fact that Europe started from a much higher base.
Having said all this, I do not believe, however, that Europe is about to enjoy a sustained economic expansion of the kind almost guaranteed in the US and Britain. The overvalued euro makes European labour costs too uncompetitive — especially in Germany, which will continue to suffer from Japanese-style deflation for many years ahead. Even if the euro falls back to earth, there will be too many labour market regulations and fiscal burdens stunting competition and enterprise.
Beyond that is the likelihood of monetary and fiscal blunders. For example, the European Central Bank seems to be thinking of raising interest rates. Any such move could snuff out the hopes of consumer-led growth, in the same way as macroeconomic blunders aborted several Japanese recoveries.
Given the deflationary monetarist dogmas of the ECB, the weakness of European governments and the recalcitrance of trade unions, the chances are that Europe will continue to follow the stagnation road map pioneered by Japan in the 1990s. But we must not forget that even Japan’s “lost decade” included several years of 2 to 3 per cent growth. With luck, Europe’s long malaise is now giving way to such a remission.
