Europe has managed over the last half century to combine a higher level of government spending than the United States with a rate of economic growth that is still respectable and living standards that many “blue state” Americans envy. Regrettably, this party may be coming to an end.
Until recently, the standard neocon economic putdowns of the Franco/German “Axis of Weasels” were simply untrue. Both France and Germany had productivity growth figures that, if put onto a corrected basis were close to those of the United States. (The European Union does not indulge in “hedonic pricing,” hence its growth in Gross Domestic Product, GDP growth per capita and productivity growth figures are around 0.8-1.0 percent per annum understated compared to those of the United States – or, for purists, the latter are overstated.)
On the other hand, high EU levels of unemployment are to a large extent voluntary; they reflect a semi-conscious judgment on the part of the political system that the least employable 10 percent of the population, in terms of social integration, education or intelligence, are better off on welfare than disrupting otherwise efficient factories and service industries. Add to this a higher level of equality (which with any declining marginal utility function must improve the overall welfare of the society) and you have countries whose modestly lower per capita real incomes may be well compensated by more leisure, better cuisine and the occasional availability of good opera.
For investors, there is an additional kicker in the EU in the introduction of low-wage Eastern European countries into the region’s economy. Unlike Mexico, whose low wages are offset by a poor education system, a dysfunctional social structure and an extremely high level of corruption, most East European countries have good education systems. (The notable exception to this among recent or potential EU entrants is Romania, whose education system was destroyed by Communist leader Nicolae Ceausescu’s Cambodian-style attempt to return everybody to the countryside.) Corruption in Eastern Europe varies from country to country, but appears to be gradually improving on average, while the social structure and income distribution in Eastern Europe suffers from the opposite problem to that of Latin America, being too egalitarian rather than too polarized.
Whereas the introduction of Mexico to the North American Free Trade Area in 1994 has done little to raise living standards in either the United States or Mexico, the introduction of Eastern European countries to the EU is producing rapid growth in Eastern Europe. It is also making many Western European companies more successful competitors on the world market as they are able to reduce the costs of their manufacturing operations while fully maintaining product quality. Unlike the United States, the EU is not running a trade deficit even against the rigors of Asian competition; this success is not solely due to protectionism but more solidly to the generally high competitiveness of European manufacturing.
It is here that neocon economic commentators go most badly wrong. Seeing Germany’s high level of taxes and high unemployment, they postulate that German industry must be uncompetitive in world markets, and theorize that this lack of competitiveness is due to the lack of innovation that high taxes and a structure tilted away from entrepreneurship brings. However, their initial postulate is wrong; German industry is not uncompetitive, as the solid German trade surplus shows. Indeed German industry has reduced its relative costs against the rest of the world by about 10-15 percent since the introduction of the euro in 1999.
Italian industry is uncompetitive, but that reflects specifically Italian problems — the country has still not fully conquered the essentially Latin American elements in its makeup. Italy was able to join the euro only by fiddling its budget figures, and it is now suffering because the low interest rates brought by euro membership have not been combined with fiscal and economic austerity in other areas, but instead have been squandered on a real estate boom and an increase in costs generally. By fiddling its budget figures to join the euro Italy demonstrated its belief that the budget constraints of the euro were not a necessity of sound economic policy, but simply a constraint imposed on Italy by outsiders, to which they must outwardly conform if they wished to receive the benefits (lower interest rates) of euro membership. The Italian political class needs to grow up.
This generally benign picture is however darkened by the events of the last few months in France and Germany. In France, a series of fairly minor and pointless riots has demonstrated that the French political system is not addressing the true needs of its people. Allowing a high level of immigration and then segregating the immigrants and their descendents away from the rest of French society in edge-city housing estates is not a recipe either for social peace or for economic progress.
The traditional admirable discipline of the French education system, so important to French economic success before 1973, was destroyed by the advent into academic and political power of the “generation of ’68,” former student rioters whose leftism was reinforced by their success in ending the mildly authoritarian and highly capable rule of General Charles de Gaulle. The political power of leftist intellectuals has always been greater in France than in any other country; not for nothing was the phrase “trahison des clerques” (treason of the clerisy) a French coinage.
The principal political beneficiary of the French riots was nationalist Jean-Marie Le Pen. While haters of political correctness may rejoice in this, it is unlikely to bring either economic success or political peace. In the Presidential election due in April 2007 Le Pen is likely to draw votes primarily from the right, allowing a Socialist candidate, probably from the left of the party, a clear shot at office. Since France is already the principal opponent of free market economics in the EU, its economic future must be dark indeed.
In Germany, it appeared earlier this year as though economic recovery was on the way, since a modest package of reforms instituted by the Social Democrat (SDP) government of Chancellor Gerhard Schroeder had been succeeded by an election campaign in which the Christian Democrat (CDU/CSU) coalition led heavily in the opinion polls and had promised more far-reaching reforms, including tax cuts, a most un-German concept. Regrettably, CDU leader Angela Merkel ran one of the most inept election campaigns on record, and having thrown away her large majority was then allowed by her party to put together a “Grand Coalition” with the Social Democrats. In the Grand Coalition agreement not only were almost all further reforms abandoned but an increase in Value Added Tax from 16 percent to 19 percent was imposed, to take effect from 1st January 2007.
At a time when inflation in Europe as in the rest of the world is once more increasing, fueled by a worldwide easy-money bubble in commodity prices, a 3 percent increase in VAT, which will inevitably increase inflationary expectations, is just what the German economy doesn’t need. Even though after 15 years the immense burden of reintegrating the East German economy at an overvalued exchange rate may finally be passing, an increase in costs and depression of economic activity is likely to kill off the nascent German recovery. Further wasteful public spending, inevitable in a Grand Coalition in which political jockeying is paramount, will only make matters worse.
Roll on the collapse of the Grand Coalition and another election – except that another election is unlikely to benefit either the inept Merkel or the free market and untainted Free Democrats, but is instead likely to cement still further the control of the left over German politics.
Finally in Britain the excessive public spending of the last five years, since Chancellor of the Exchequer Gordon Brown freed himself from his self-imposed intention to follow pre-1997 Tory spending plans, is now bearing its expected fruit. British GDP growth, which had been expected at the time of the March Budget to run around 3.0-3.5 percent in 2005, was revised down to 1.75 percent in Brown’s pre-budget report last Monday, while the public sector borrowing requirement was forecast at 37 billion pounds. Since public spending increases on the National Health Service and education are locked in until 2008, taxes will have to rise or the deficit will spiral out of control. The rise in British public spending from 39 percent of GDP in 1997 to 43 percent of GDP in 2005, with more to come, will inevitably slow British economic growth to a crawl and in turn worsen the public finances.
Since the next British General Election is not due until 2009 at the earliest, the outlook for the British economy must also be bleak. Further, while the new Conservative party leader David Cameron is likely to win that election, particularly if a recession and tax increases have intervened before then, it is not clear whether such a victory will achieve anything.
Cameron is an Old Etonian, a species that over the centuries has been particularly prone to betrayal. It is not yet clear however which side he will betray. If he is truly the liberal-left soft-hearted party animal that he is portrayed, he will betray millions of Tory voters, leaving them with no major party to support, no alternative to ever-aggrandizing government. There is however also the possibility that he will betray the media and metropolitan elites who have been so cock-a-hoop over his election and turn out to be a real Tory, cutting back the Leviathan state in an appropriately Thatcherite manner. Surely the latter would be the more unexpected betrayal and is therefore perhaps the more likely! One can only hope.
Europe has enormous strengths in the skills and education of its workforce and the quality and innovativeness of its major companies. It also has substantial advantages over the United States in the highly productive cheap labor that is joining the EU through its enlargement process, and the relative lack of pressure from excessive population growth. Only European politicians can spoil the picture – but they currently appear to be making every effort to do so.
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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.