That isn’t a headline that you see in mainstream economy commentary. The standard story – one that is echoed in communiqué after communiqué – goes something like this.
Global rebalancing – code for a set of changes that will slow demand growth in the US and increase demand growth outside the US to help reduce the US deficit and the rest of the world’s surplus – requires policy changes in Asia, the US and Europe.
Somehow, the oil exporters usually get left out despite having a bigger surplus than anyone else.
What does Europe need to do contribute more to global demand growth? Reform its labor and product markets. It hasn’t done so. So it won’t be able to contribute to global rebalancing.
One problem. The story isn’t true. Not right now. Europe may not have reformed. But it sure has contributed to global demand growth over the past year and a half. My evidence? European imports.
Imports are the most direct way Europe contributes to global demand growth. AndtThey are way, way up. Eurozone goods and services imports grew around 20% y/y if you compare q1 06 v q2 06. Q2 was a bit slower – the January-June 06 growth rate was only 17.5%. For the first half, Eurozone imports are up 18.6% y/y. US goods and service imports are up a paltry 11.9% by comparison.
Look at the following graph. I set q1 2005 imports for both the US and Europe at 100. Guess whose imports grew faster?
It isn’t all oil either. China doesn’t export oil. And European imports of Chinese goods are growing faster than US imports of Chinese goods. The Q1/ q1 growth rate for European imports from China was 27.6%; it slowed a bit in q2, bringing the y/y growth rate down to 26% or so (January-May 06/ January-May 05) . That is still higher than the 16.8% y/y growth in US imports from China though. And Europe, unlike the US, pays for its imports with a hard currency backed by real export capacity, not just a comparative advantage at producing debt …
Those in Asia debating whether China will allow Asia to decouple from the US are perhaps debating the wrong thing. They should be asking whether China can decouple from Europe. Remember, Chinese exports to Europe have been growing faster than Chinese exports to the US for most of the past five years.
Rapid import growth has pushed the eurozone’s current account into deficit. Euroland’s deficit is nothing like the US deficit of course. But it is not trivial either – the 12 month euroland current account deficit was around 40-45b euros. Compare that with a 50b euro surplus in calendar year 2004. Over an 18 month period, that works out to a swing of around 90b euros, or roughly $115 dollars. That swing shows up clearly in the chart the ECB releases every month.
If the US runs a current account deficit of $220b in q2, the US deficit will have increased from $667b in 2004 to around $837b or so – a swing of around $170 billion. That is slightly bigger than the swing in euroland – but euroland’s economy also isn’t as big as the US economy. I bet the swing in the EU-25 is comparable. The Brits are usually good for a big of extra spending …
The facts are pretty clear. Europe has delivered a big impetus to global demand over the past 18 months. Despite the absence of the labor market reforms proscribed by the great and good gathering at Jackson Hole.
Or maybe because of the absence of the proscribed labor market reforms – their impact on demand growth has never been all that clear to me. If more job uncertainly leads to more savings (and if labor market liberalization leads to downward pressure on real wages in some sectors … ), the overall impact on demand growth is ambiguous at best. And I doubt European firms are pushing hard for labor market flexibility because they are desperate to raise wages faster than the rigid unions will allow. The link between labor market reform and demand growth seems pretty thin to me, at least in the short-run.
Housing market froth – thank you Spain and France – seems far more correlated with demand growth than labor market reform. Combine housing market froth and a relatively strong currency also helps pull in imports and, well, you get Europe over the past 18 months to a year …
Relative prices matter, not just institutions.
So what is the problem? I can think of two.
First, Europe’s mini-boom may be ending. The data is contradictory. Some German business confidence data is encouraging; other German business confidence numbers are not so encouraging (hat tip, Claus Vistesen). The same forces that pulled down the US housing market may eventually hit Spain and France.
Second, Europe’s mini-boom helped China increase its surplus more than it helped the US reduce its deficit. Look at the comparative growth of US exports and Chinese exports to Europe. To make life simple – I used the European import data, but it amounts to the same thing. The data is in euros – the increase in dollar terms in more impressive.
US exports to Europe are up. But nothing like Chinese exports!
To bring about true global rebalancing, European imports not only need to boom. That already has happened. But the US needs to benefit far more than it has from that boom.
The most recent European import boom helped push up China’s surplus – and China’s capacity to finance the US. Not to push down China’s surplus. The Economist, Lex, the IMF and those drafting the next G-7 communiqué might want to take note.
Someone should give Europe credit for supporting strong global demand growth over the past 18 months, and slowing the deterioration in the US current account deficit.
Another little known fact: Europe increasingly looks like the world’s true venture capitalist, taking in funds from emerging markets (central banks and oil funds) looking for safety and using those inflows to finance European FDI. Look at the capital flows data. But that is a story for another time …