Mixed Feelings on the Eurozone
Well, well since the ECB chose to hold rates steady last week there has certainly been a lot of blogging about the Eurozone. Before we move on, I believe it would be fruitful to re-coup some of the questions which divide the opinions here.
1. Is the Eurozone recovery sustainable?
2. Will the Eurozone decouple from a US slowdown?
3. In fact, will the zone be able to take over where US is now pulling the brakes in leading forward the global economy?
These are the central questions of the current debate I believe and in terms of my own position here I have leaned towards a three-fold NO in my recent writings on the topic. Obviously, none of us can claim to be on the truth's side here since we are all speculating based on the current and future reality as we see it. On that note, let us start with some news which gives the optimists ammunition for arguing their case.
In terms of question 1 the word 'sustainable' obviously springs out of the screen because what is in fact a sustainable recovery? More on that later ... meanwhile let us rejoice in some good news on economic growth in the Eurozone from the Eurozone Watch blog.
'Today, Eurostat has confirmed what we had anticipated on the Eurozone Watch blog two weeks ago. Growth in the euro area has been stronger than previously thought: In year-on-year-terms, growth now runs at 2.6 percent, rather than the 2.4 percent previously reported. Moreover, with the revisions of past quarters, it now looks quite likely that the growth outcome for 2006 as a whole will be even above the mid-point estimate of the ECB of a growth rate of 2.5 percent.'
This is indeed good and although 2.5 percent is not stellar it is not bad at all. Furthermore New Economist reports on an interesting long term trend in the Eurozone economy, namely an accelarated growth in productivity.
'Eurozone productivity is picking up, according to Morgan Stanley economist Eric Chaney. In a recent note to clients, he concluded:
'One thing has escaped analysts' attention since the beginning of the year (for lack of official statistics): labour productivity has significantly accelerated in the euro area. On our estimates, hourly productivity has increased by 2.4% (annualized rate) in the first half of the year, compared with 1.3% since 1999. I believe [Eric Chaney that is] that the resurgence of productivity is not merely cyclical (...)'
This one is obvious very important to watch out for in the long run since all my talk about ageing populations, high unemployment rates, fiscal tightening, etc in theory can be countered if European productivity catchs up vis-à-vis the US. I am not sure I am buying it though but definitely one to keep an eye on.
This is question 1 then and although there are good signs coming out of the Eurozone we cannot say anything about whether it qualifies as sustainable. Luckily the answer to this question brings us right smack into question 1 and 2 cited above. Because if the Eurozone really picks up where the US economy has left then surely it must qualify as a sustainable recovery in every sense of the word.
Concerning question 2 and 3 they are obviously interconnected. Answering no to 2 entail no to 3 as well! Let us look at the arguments then shall we?
A week ago Brad Setser hit me with the idea that the Eurozone actually might be the driver of global demand going forward. And as if Brad Setser is not bad enough to tackle he is now, at least to some extent, joined by Kenneth Rogoff and Eric Chaney (hat tip Brad Setser) and none other than chief economist at the OECD Jean Cotis.
In reality Rogoff is balanced in his analysis which effectively talks about IMF's role in untangling those global economic imbalances. He clearly thinks the Eurozone might be able to effectively help unwind the imbalances in the short run but it rests on a different course by the ECB and particularly the national governments ...
'With Europe in a cyclical upswing, tax revenues should start rising even without higher tax rates, so why risk strangling the continent's nascent recovery in the cradle?
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.'
In essence Mr. Rogoff has the main point here but I just, in all modesty, think he gets it all loopsided. It is true that fiscal tightening risks undoing the good signals from the Eurozone but where Rogoff talks of choice I think we are well past that choice actually and almost all big Eurozone countries (most notably Italy and Germany) are locked in towards a path of fiscal tightening for some years to come. Moving on to Eric Chaney he is as Rogoff also very balanced in his analysis, yet the bottom line seems to be that ...
'Brick by brick, official statistics are painting a macro story that we had largely sketched as soon as December 2005, with the impression of preaching in a desert. In short, the euro area is currently enjoying a robust recovery, essentially fuelled by domestic demand: GDP growth has averaged 3.4% in the first half of the year (annualised rate), with final domestic demand growing at a robust 3.0% speed, according to new data released by Eurostat on Friday September 1.'
To be fair to Mr. Chaney his article has many important points on the Eurozone in general and as such merits a close read beyond the quotation above. All in all though he is stamped as an optimists in this post. Leaving Chaney we find ourselves in the company of OECD's chief Economist Jean Cotis who in his recent outlook for OECD economies (linked above) gives his view on the issues as well.
'In the euro area, activity accelerated in the second quarter, partly catching up with upbeat business confidence indicators. Several transitory factors helped, notably the soccer World Cup and time-bound subsidies in the construction sector in Germany. Domestic demand in the euro area benefits from the pickup in employment growth in the two largest economies, and area–wide unemployment has fallen to below 8% of the labour force for the first time since 2001. Given the stronger-than-expected momentum in the first half, year-average GDP growth is now slated to reach 2.7%.'
'In the euro area, the recovery now seems sufficiently robust for a return towards a neutral monetary stance, but gradually so, since unit labour costs remain well in check.'
Peew ... that was some rant. It is clearly unfair to claim that all the sources cited above are ardently arguing that the Eurozone's recovery is sustainable which in this case would mean that it was ready to pick up as the US slows down. To argue that would not fully include the degree balance in the analyses. Moreover, there is clear grounds for optimism in my opinion concerning the Eurozone but in the end I assume my pessimitic stance and I do so because I (still) do not believe the fundamentals have changed ... 1) The ECB still looks hawkish although the recent pause suggests that the idea of 'advesity to reversal' is not as prevalent as we might have thought; see Chaney here as well. 2) Fiscal tightening is still on the horizon. 3) The US is in fact slowing and I do not believe the Eurozone can escape this entirely, and 4) Germany and Italy are ageing rapidly which cannot but affect growth rates especially if we mention the damned word 'sustainable' again.
Ending this post I would like to bring to your attention two very to the point posts from my colleague at Demography.Matters Edward Hugh who has emerged from summer blogging hibernation with a venegance. Like me he also believes that caution is needed here; he also sums up the argument on fiscal tightening.
'For all the admirable sentiment from Ken Rogoff that strong growth in the eurozone would help power the growth needs of the international economy the tax raising exercise unfortunately makes perfect sense since unsustainable fiscal deficit profiles have been maintained in some key economies (Germany, Italy, Japan) throughout the entire course of the upswing in the latest global cycle, and this of course has to come to an end at some point.'
'So based on a rudimentary headcount that makes the US, Japan and the eurozone to be slowing, leaving the global economy train to be pulled by China, India, Brazil etc, all of whome to greater or lesser degress need to export to those who are slowing. Anyone have a dictionary definition of 'sustainable' to hand?'