Over the years we have seen a number of projects and initiatives trumpeted as the magic solution to ...
Over the years we have seen a number of projects and initiatives trumpeted as the magic solution to the supposed European economic malaise. The 1992 European Single Market was billed as a measure that would end 'Eurosclerosis', a condition under which Europe had enjoyed low inflation but low economic growth as well. In a microeconomic sense, the removal of trade barriers certainly helped some companies to prosper, and others to fail, but in aggregate it seemed to have a relatively limited effect on economic growth and prosperity in the region.
After the Single Market project came a huge fiscal expansion in the region. This delivered around a year's worth of growth but unfortunately petered out and left a number of governments facing debt problems in the future. Next came the euro project and the promise of improved competition through transparent pricing and easier foreign trade. In a micro sense, the euro project is helping to make trade easier for individual companies but, at a macro level, European growth and employment have not so far lived up to the promises that were made.
In fact, the macro implications of the euro have been very two-edged. Trade may be easier but Ireland, Spain and, arguably, France have been launched off into credit booms that could prove to be very damaging in the future. Furthermore, the euro did not have a flying start at issue on the foreign exchanges. Rather than appreciating, as almost all commentators expected, it sank at what some believed to be a crisis rate.
The next likely initiatives will focus on tax and savings reforms. European governments are moving to reduce tax burdens on consumers, savers and companies in an effort to encourage more spending and better capital market activity. Pension and savings reform is also under way in an attempt to encourage people to save less in the humble bank deposit and more in the exciting equity markets.
In the US, individuals held 63% of their financial assets in domestic equities in 1999, as opposed to 47% in the UK. The continental economies such as Germany (15%), France (24%), and Italy (35%) generally have much lower ratios. There is a belief that if Europeans save more through the equity markets, there will be a microeconomic improvement in capital market efficiency which could help the European corporate sector match its seemingly more vibrant peers in the USA.
European governments would also like to see more people start to save in equity markets as a way of reducing their commitments to state-provided pension provision. The social security budgets of most European nations are grossly underfunded, by a multiple of the countries' GDP, and anything that helps lessen this burden is likely to be welcomed by the finance authorities.
In terms of micro initiatives, it is difficult to fault the European governments even if the initiatives have generally tended to take longer to implement than intended. Even the single currency was nearly 20 years behind schedule. What is less obvious is that macro initiatives have generally been few and far between. Interest rates occasionally move up or down with the cycle, but these moves almost seem to be grudging at times.
In the USA and, to a lesser extent, the UK, one rarely hears about the micro side of economics. This is partly because the US has fewer regulations and therefore freer markets and less need of micro reform. But, as an observer of both regions, it would seem that macroeconomics has a higher weighting in the US than in Europe. Perhaps this is a lesson that Europe should learn.
The German economy is slowing at the present time, potentially quite significantly. This is being caused by weaker exports, a by-product of the global slowdown, and disappointing capital spending. Germany's response seems to have been to blame a lack of labour reform and consider changes in the tax system. But, however beneficial these changes may be in the long run, their effect on short-term growth prospects could be quite limited and unpredictable. Germany's answer may be beneficial in the longer term but, as Keynes remarked, in the longer run we are all dead anyway.
We suspect that if German companies could be made more confident that their economy would not be forever at the mercy of the world trade cycle, they might want to invest more, even in the absence of micro reform.
Similarly, France may be growing strongly now, but this growth seems to be built on interest rates that are too low and a credit boom. French mortgage lending is very strong and it seems that the local property market is extremely strong. While this may be adding to confidence and spending in France at the moment, we in the UK know only too well what happens when a property boom turns to a bust. Higher property prices will cause wage inflation to rise as workers respond to the higher cost of living, as they are in Ireland currently, and the country will soon lose its competitiveness and ultimately struggle to maintain its growth rates and investment.
In fact, Germany and France are really just experiencing different sides of what amounts to the same coin. When the euro project was announced, the Deutschmark and the French Franc were essentially jammed together at a rate that was too low for the Franc and too demanding for the Mark. As a result, France is too competitive and there are too many projects that are viable at the current level of interest rates. France is therefore growing rapidly and will ultimately experience a higher relative rate of inflation.
In Germany, the higher exchange rate means that there are fewer viable projects at the prevailing level of interest rates so the domestic economy appears to be quite sluggish. Germany is dependent on an external stimulus for its growth and slows down in the absence of such a stimulus. This is what we expect to happen in 2001, but th
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