Both Morgan Stanley (at least Eric Chaney) and JP Morgan (in their latest global outlook) now recognize that Europe has emerged as an important engine of global demand growth.    Indeed, the 2005 surge in European demand seems to be reasonably well correlated with the surge in US pessimism about Europe.  Europe, the story went, couldn’t generate the political consensus to make the necessary labor and product market reforms, so it wouldn’t be able to support global demand. 

What did that story leave out?  Low European interest rates and the housing market.  I have often argued that Europe (France included) looks a lot more like the US than most folks realize.   Job growth hasn’t been all that impressive on either side of the Atlantic.  Indeed, by some measures, it has been better in old Europe.  Real compensation growth hasn’t been all that impressive on either side of the Atlantic. 

And in both regions, frothy housing prices have supported consumption growth.

Today, I am turning the blog over to Charles Gottlieb of the European Capital Market Institute and the Center for European Policy Studies.    He is writing in his own personal capacity – the usual disclaimers apply with force. 

His topic: the European housing boom (or bubble) – a topic he also wrote about in the Spring for the ECMI.   There is a lot of interesting material — and a few nice graphs – below the fold.  Enjoy.

Read more »

I quite liked Ken Rogoff’s policy prescriptions for global rebalancing. 

Specifically, I thought Rogoff got two key things right.

First, He recognizes that Europe already is contributing to global rebalancing.   The euro is kind of strong, especially against Asian currencies.  And recent European growth has been domestic demand-led growth.  Eric Chaney:  

the euro area is currently enjoying a robust recovery, essentially fuelled by domestic demand … Companies and consumers have proved more sensitive to the large monetary stimulus applied by the ECB since mid-2003 than most analysts had thought. 

That demand growth is propelling exceptionally fast y/y growth in Eurozone imports – and has pushed the Eurozone current account into a significant deficit. 

Consequently, Rogoff emphasizes the need for Europe to avoid taking policy actions – such as Germany’s VAT increase — that risk slowing European demand growth rather than supply-side reforms whose short-term impact on demand is ambiguous.

“Europe, for its part, could agree not to shoot its recovery in the foot with ill-timed new taxes such as those that Germany is currently contemplating.” 

To be clear, I rather suspect Rogoff thinks Europe should also implement some supply-side reforms.  But he didn't tie the case for those reforms to global rebalancing.

Read more »

The (unnamed) “analysts” have spoken.    The yen won’t rise above 113 v the dollar even if the US economy slows significantly, slowing the global economy.    Ahmed and Lindemayer report in today’s Wall Street Journal:

“Slower global growth also will encourage Asian central banks and governments to stand in the way of a sharp appreciation of their currencies.   Any fall in the dollar would be limited to 113 yen, and any rise in the euro would peak at 1.30, after which the dollar would recover, said analysts.” 

How do the analysts know that the yen won’t breach 113, I might ask?

A few years ago, growth and interest rate differentials were good for the dollar.   Now apparently slow US growth (and falling interest differentials) are good for the dollar.   

The first point – than Asian central banks will intervene if their currencies start moving up — is probably right.   I never knew that the Japanese were defending the yen/ dollar at 113 though.    That would still leave it very weak in real terms against the dollar – and exceptionally weak in real and nominal terms against the euro.  See the analysis of Teis Knuthsen of Danske Bank.  At least the part of his analysis that covers the euro/ yen and the overall real value of the yen. I am less convinced that the dollar/ yen is close to fair value than Knuthsen.  

That Asia likely will try to prevent Asian currencies from appreciating against the dollar as the US slows –and thereby keep Asian currencies exceptionally weak against Europe is a bit of a problem for the global economy.  I cannot think of a better way to undermine European support for our current brand of globalization than a persistent misalignment between the euro (and other European currencies) and the main Asian currencies. 

Indeed, I increasingly think the Asia/ Europe exchange rate more out-of-whack than any other set of prices in the world economy.  OK, it is second biggest price misalignment.  The gap between oil prices and the oil states currencies is number one (together with the related gap between oil state revenues and oil state spending).   But Asia/ Europe is becoming a close second.

Read more »

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?

Read more »

Daniel Gross has noted one other way the US and continental Europe are more alike than different – corporate success hasn't translated into broad-based wage gains.    Corporate profits are rising relative to GDP in Germany and France, not just the US.   Gross: 

For example, median incomes for American workers have barely budged since 2000, while corporate profits have nearly doubled. In Germany, wages have fallen in real terms in the last two years, while earnings for the companies in the DAX 30 index have more than doubled. And in Germanyand much of the rest of Europe, the overall pace of economic growth has remained sluggish.

"All in all, the widespread prosperity of companies does not lead to prosperity for domestic economies or wage earners in Germany, France or Japan," wrote Patrick Artus, chief economist of IXIS, the Paris bank, in a recent report.

The other similarity between the US and Europe, of course, is the one that I noted on Friday – well illustrated by Daniel Gros (A European economist, not uber-economics journalist Daniel Gross):  current account deficits in Europe are closely correlated with rising housing prices.

Why has German economic performance lagged that of France as well as the US? Corporate profits are up in all three countries.  But housing prices are up in only the US and France.   And as a result, consumption growth/ demand growth has been relatively strong in the US and France, but not in Germany.  

Daniel Gross also notes – I think correctly – that so long as the gains of globalization are not broadly shared, it hardly should be a surprise that the political consensus that favors globalization is fraying.  He cites Stephen King of HSBC.

"When you have labor shares shrinking relative to capital shares, you tend to get a rise in economic nationalism, which is a democratic response to some of the effects of globalization," Mr. King said.

Read more »

That's a headline you won't see in the financial or popular press. 

The basic narrative is already established:  France won't change, and as a result, will lag behind the more flexible "Anglo-Saxon" economies.

French labor market and social institutions certainly do differ from those in the US.  Personally, I think the US could learn a thing or two from France's health care system (I have direct experience with both systems, having lived in both countries).    And I suspect France could learn a thing or two from the US as well.  Not all aspects of the French model are working right now.

But a bit of modesty is in order too.   The US hasn't exactly done much better creating private-sector jobs than France – and some private sector jobs stem from a surge in government spending, as Kash notes.  The case for emulating the American model would be far stronger is the gains from higher productivity were broadly shared.   Massive structural reform so that CEO productivity (and pay) can go up isn't going to appeal to everyone.

But the established narrative that focuses on France's resistance to market liberalization – Anglo-Saxonization, so to speak – misses one key fact:  France, despite the absence of reform, has enjoyed domestic-demand led growth for the last ten years.  Sort of like the US.     Germany has done more reform but has far less growth in domestic demand.  And Italy lags in all respects.

France isn't the America of the Eurozone.  Spain wins that title.  Huge housing boom.  Huge current account deficit.  But France runs second – at least if you look at most macroeconomic variables.  

French housing prices are frothy.  See this BNP report on Spain – it provides lots of useful cross-country comparison.   French domestic demand growth hasn't kept pace with the US, but it has far outpaced domestic demand growth in Germany.  It certainly tops the Eurozone average.  Imports are growing faster than exports.  And France's current account balance has shifted from a surplus to a deficit.  UPDATE. Daniel Gros has a nice chart on p. 7 of this .pdf showing the correlation between European housing prices and European current account deficits.

In other words, France has done what the US now wants from the rest of the eurozone: it has grown on basis of domestic demand, not exports.  

Read more »

Apologies for being one day late discussing a Peaple/ Teitelbaum article in Monday's Wall Street Journal called "UK business investment lags."  My title is intentionally a bit overstated, but I was struck by the fact that UK business investment is (and consistently has been) lower than in Germany and France.  That was not would I would have expected based on the standard "dynamic" Anglo-Saxons, stagnant Continent" storyline.

I don't think anyone doubts that the UK has done more than the big continental European economies to create an American-style flexible labor market.  And there is little doubt that UK economy has been a bit more dynamic than others in Europe.  Even the food is a bit better than the French think …  London's restaurants have taken off along with London's financial sector and real estate prices.   I hear that BP is also profitable these days. And the UK seems to be the center of global petrodollar recycling – gathering the fees associated with bringing spare Russian and Saudi dollars together with American borrowers in need of funds, so to speak.  That is a nice little line of business. 

The standard story is that if the continent adopted UK style reforms they too could experience UK style growth and dynamism.  Specifically, the reward for reform would be higher levels of investment.  Why, people ask, invest in Germany and France and take on workers who you cannot fire workers and have to contribute heavily to their national social insurance systems?

Yet, according to Peaple and Teitelbaum of Dow Jones (no link, story was on p. A18 of Monday's Wall Street Journal), despite existing rigidities, business investment in Germany is already well over 12% of GDP – 12.9% of GDP to be precise.  Business investment in France is only a bit under 12% of GDP – 11.3% of GDP.   While business investment in the UK is only 10% of GDP.  And I certainly would not have guessed that business investment in Germany has been around 3 percent points above that in the UK over the past few years.

I have yet to read Olivier Blanchard's paper on what we know about labor market institutions and labor market reforms – and what we don't.  But from what Mark Thoma writes, it sounds interesting.  "Protect workers not jobs" seems right to me. 

And based on a superficial look at the European data,  I like Blanchard's call for a bit of humility.  There does not seem to have been a strong correlation between labor market "reforms" (or perhaps flexible labor market institutions) and higher levels of business investment in Europe over the past ten years.  Now it is possible that greater reforms would lead to higher levels of business investment in Germany, or that absent reforms, investment will fall to a lower level in Germany than the in UK.   But it hardly seems like a sure thing.

Read more »

I agreed with a lot of what Fareed Zakaria wrote about Germany – certainly I would agree that Germany has done a lot more reform than France over the past few years.

Compare Germany with France. In Germany, both parties have serious reform proposals, and one has carried out some of these. There are numerous think tanks that explain why such reforms are necessary. A large part of the German press and business elite supports them vocally. None of this is true of France. There is more serious discussion about economic reform in one month in Germany than there is in one year in France.

And it is not just talk. German industry has begun a process of deep restructuring, forced by the pressures of global capitalism as much as by any government policies. Last week, despite the election results, Mercedes confirmed 8,500 job cuts and Volkswagen announced that it would keep a plant open because its union had agreed to large cost reductions. As a result of such measures, Germany's most competitive industries already are strengthening. Only two major economies have actually gained in their share of global exports of manufactured goods in the past five years: China and Germany. Last year Germany became the world's leading exporter of goods, larger even than the United States, despite the fact that the U.S. economy is five times as large. Germany's labor productivity is as high as that of America's, and its unit labor costs are now lower.

Unfortunately, if you look at the data, it is hard to argue that Germany is has been rewarded for reforms designed to make its economy more competitive.  

From 2001 on, when, as Zakaria notes, Germany has tried to reform its labor market institutions and France, broadly speaking, has not, German domestic consumption has increased by a measly 1.6% (that is the cumulative five year increase through the end of 2005, according to the IMF, not the annual increase).   What happened in France?  Consumption is up 11.1%. 

Average real growth rates tell a similar story.  From 2001 to 2005, real growth averaged 0.7% in Germany, 1.6% in France and 2.6% in the US.   Remember, the US population is growing by about 1% or so a year.  So in real per capita terms, France broadly kept pace with the US, while Germany did not. 

The simple correlation is more reform, less growth and far less domestic demand led growth.  I do not think this argues that Europe should sit still – some reforms are certainly needed.  European states have promised a bit more than I think they can realistically afford to deliver.

Read more »

Growth over the past ten years (all data from the IMF)

USA:  3.3 (05 estimate: 3.5); Spain: 3.7 (05 estimate: 3.2)

Current account deficit (percent of GDP) 

1997

US: -1.7; Spain: -0.1

2005 (estimate)

US:  -6.1  (too low, by the way — -6.6 or -6.7 would be more realistic); Spain: -6.2 

Change:  US: -4.4 (-5.0 if you trust my numbers).  Spain: -6.1  

Growth in final domestic demand, 97-06 

USA: 3.7%; Spain: 4.0%

And for the sake of comparison -

France: 2.4%

Germany: 0.8% (and none since 2001) 

Read more »

David Wessel writes in today's Wall Street Journal: "Germany, alas, is showing few signs of a Japanese style rebound.  It is, essentially, relying on lower wages to make exports more competitive because it hasn't boosted consumer spending or business investment."

That sentence might well work better if read "Germany has had trouble boosting consumer spending because it has needed to lower wages to make its exports more competitive (and also to make German product more competitive in Germany)."    The cause and the effect are not clear.  Has low consumer demand kept wage growth subdued?  Or has German consumer demand been subdued because German wage growth has been (very) subdued?

I am a bit more cautious than most about projecting a massive boom if Germany implements efficiency enhancing reforms.  The link between reform and growth is not obvious in the short-run.  The dislocations associated with efficiency enhancing reforms (efficiency enhancing reform is economese for making it easier to fire people among other things … ) can dampen consumer spending, as workers worry that they may lose their job and start to save more.   Long-term efficiency improvements do not always translate into higher consumer spending in the short-run.  One potential explanation for why consumer demand has been so weak in Germany (see the OECD data) is the fact that Germany has started to reform.  Unit labor costs in Germany are falling.   That may be part of the reason why German household savings rose from 9.7% to 10.7% between 2000 and 2003.

The connection between reform and higher long-term growth is also not a sure thing.  Work by Ricardo Hausmann, Dani Rodrik and Lant Pritchett suggests there is no guarantee that "more reform = more growth."  To quote a key conclusion of one of their recent papers: "most instances of economic reform do not produce growth accelerations."   That conclusion is most obvious looking at Latin America, but it does suggest to me that a higher degree of humility is called for.  Most commentators that I know would not have predicted that China's (largely unreformed and NPL ridden) state-owned banks could finance a growth explosion …

I do think Germany needs to do more to prepare for a world where the US no longer supports global demand growth, and to make sure the German government's future commitments are commensurate with its resources.

But American commentary – in my view – might be strengthened if it emphasized two things:

a) Investment in Germany is now lower about 2% of GDP lower than investment in the US.  But I would guess that higher investment in housing accounts for most of the difference …  and I am not sure all the capital now being invested in the US housing stock is the best use of available resources.  Investment in tradable production is probably higher in Germany.  The composition of investment may matter as much as the level.  Higher investment in Germany's export sector may not help with global rebalancing; what is needed is a surge in investment in Germany's non-tradable sector.

Read more »