Seeing Europe the right way up

Europe's economies

Nov 17th 2005
From The Economist print edition

The euro area's economies are in better shape than they look

GERMANS vote against economic reform; France's young unemployed riot; and the European Central Bank (ECB) seems to be itching for an excuse to raise interest rates and strangle the euro area's feeble economic growth. For sceptics, nothing has changed: the single currency zone's economies are a miserable sight and will remain so. But if they took a careful look from another angle, they might see an altogether happier picture.

At the very least, European economies are picking up speed. Figures published this week showed that the euro area's GDP grew by 0.6% in the third quarter (2.6% at an annual rate), the fastest for a year and a half. Germany, France and Spain all managed 0.6% or better; Italy and the Netherlands reported growth of only 0.3%.

By American standards this looks sluggish: America's GDP grew at an annual rate of 3.8% in the same quarter. Even so, euro-area growth is now above its supposed potential rate of around 1.8%. This is below the American trend of perhaps 3% partly because of Europe's slower productivity growth. The main reason, though, is that America's population is increasing much faster than the euro zone's.

The composition of the whole zone's third-quarter growth is not yet known, but Germany's official statisticians have ascribed almost all of their country's GDP growth to net exports and investment. Economists at HVB, a big German bank, reckon that private consumption probably shrank for the third quarter running, for the first time on record.

Elsewhere, the pattern is reversed, with consumer spending contributing far more and exports far less. The idea that growth in the euro zone depends almost entirely on external demand, while domestic demand stagnates, is a myth. Morgan Stanley calculates that for the zone as a whole, net exports have contributed only 0.1% of the 1.9% average growth in GDP since 1999.

Even in Germany there are now signs that domestic demand is stirring. Bank lending to firms and households has started to rise after falling for most of the past three years. The latest survey of business confidence by Ifo, a Munich research institute, showed a strong uptick in retailing, suggesting that consumers are opening their wallets. And throughout the euro area, surveys of business and consumer confidence continued to rise in October, which bodes well for the current quarter. The Economist's most recent poll of forecasters still predicts average growth in the zone of only 1.6% next year, but this could prove too pessimistic.

Whether the recovery lasts depends on the labour market. In Germany intensive corporate restructuring has depressed jobs and wages for several years. Only if more jobs are created will consumers spend more. There are some hopeful signs. The euro area's unemployment rate has fallen by more than expected in recent months, from 8.8% in April to 8.4% in September.

Several countries' jobless figures may be distorted by special employment measures and changes in rules for claiming benefits, but surveys point to an improvement in underlying conditions. This is the result of various labour-market reforms as well as a cyclical upturn.

Though labour markets remain stiff, they are not as rigid as they were. Indeed, the unemployment figures may understate the overall gains: employment has risen by far more than unemployment has fallen as reforms have dragged previously discouraged workers back into the labour market.

Spain has enjoyed the fastest expansion in jobs, 4% a year since 2000. And Italian employment has risen by an annual average of 1.4% in the past six years. This partly reflects the emergence of workers from the black economy into the official realm, but some of the increase is real, thanks to new, more flexible types of job contract. Italy's jobless rate, almost 12% in 1998, is now 7.7%. Germany is the only big euro-zone country whose unemployment rate has not fallen in the past decade.

Germany's new grand coalition government has eschewed further structural reform and is focusing instead on reducing the budget deficit. It plans to lift the rate of value-added tax from 16% to 19%, but not until 2007 (see article). This could boost spending next year if it encourages consumers to bring purchases forward—but clobber it when the tax increase takes effect. Some economists also worry that the ECB will throttle the euro area's recovery by raising interest rates too soon. Comments after the central bank's policy meeting on November 3rd suggest that rates could rise as early as the next one, on December 1st. A quarter-point rise is unlikely to do much harm, however, because real interest rates would still be negative.

Europe's surprising secret

Yes, yes, sceptics might say, but one quarter's decent growth and a few reforms here and there don't alter the unprepossessing long-term picture. In fact, Europe's performance has been better than the conventional wisdom says. Although America has outpaced Europe this year, over the past five years GDP per head, the best single measure of economic performance, grew at an average rate of 1.4% in the euro area, just behind America's 1.5%. Ah, but America is better at creating jobs, isn't it? Actually, no. Employment has grown a tad faster in the euro area than in America whether one looks at the past five years or the past ten—a striking improvement on the decade to the mid-1990s.

Since 1996 the proportion of the population of working age with jobs has fallen from 73% to 71% in America; in the euro area it has risen from 59% to 65%. The fact that the euro area has achieved its growth without enormous increases in its current-account and budget deficits might also indicate that its record is more sustainable than America's.

This is not to say that everything is rosy in euroland. Far from it. Europe has to cope with a shrinking workforce and an ageing population, as well as fiercer global competition. Europe's markets will have to become more flexible, its people will need to work for longer and its productivity growth must improve. Yet, given that Europe's unhappy economies have not been doing so badly compared with America's jollier one, the rewards from further reform might be all the greater.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.