No cause for celebrations across Europe just yet

Anatole Kaletsky: Economic view

With economic figures around the world now indicating that the Great Recession is more or less over, the big question is what sort of recovery to expect. My hunch is that this economic cycle will follow the normal historic pattern.

This means that the recovery will be stronger than generally expected in America and possibly in Britain, while in continental Europe and possibly Japan the depth of the recession will produce longer-term structural problems that limit growth for several years ahead.

The prospects for a relatively strong recovery are suggested by quite a few forward-looking statistics: the biggest six-month rally since the early 1930s in global equities, and especially in cyclical shares; the rebound in OECD leading indicators; the sharp improvement in the British housing market (and more recently in US housing, too); and last week’s announcement by the New York-based Economic Cycle Research Institute (ECRI) that its future economic growth indicator, which has had an excellent record in tracking previous recoveries and recessions, has just hit a 26-year high.

As Lakshman Achuthan, the ECRI’s managing director, told Reuters on Friday: “It is high time to break from the herd of pessimistic analysts who will continue to bemoan economic weakness long after the Great Recession is history.” He added that recovery in the coming quarters is likely to be stronger than in any American cycle since the early 1980s, when GDP growth accelerated for several quarters to more than 5 per cent.

That is the good news, if you want to believe it. But what about all the financial chaos, the consumer deleveraging and the global imbalances that have made this recession so different from any in the past?

Unprecedented events are, by definition, impossible to analyse on the basis of past historical relationships, which provide the only solid evidence that economists and financiers have to go on. Given the near-death experience suffered by the world economy last autumn, when the global banking system almost collapsed, scepticism about a neatly symmetrical V-shaped economic cycle is understandable and probably justified.

What is much harder to understand is the growing confidence about economic recovery in Europe, in contrast to the continuing widespread pessimism about the prospects for Britain and the United States.

Conventional wisdom holds, of course, that America and Britain, because of their dependence on finance, have been hit much worse by this recession and now face years of debt repayment, while Europe has been less affected by the financial upheavals and should find it easier to return to sustained growth. But there are several reasons why this conventional wisdom appears to be wrong.

First, this recession has, contrary to general expectations, been only slightly worse than previous US downturns, while in continental Europe and Japan it has been a genuinely unprecedented disaster. Hence history may be a better guide to the shape of the recovery in America than in Europe and Japan. Britain’s experience may lie somewhere between.

While there has been a certain amount of schadenfreude in Europe about the fact that Germany and France grew marginally in the second quarter while the US and British economies continued to decline, the fact is that the collapse in Europe last October was so severe that output simply could not go on falling much longer without Germany and other leading European economies disappearing off the map of the world.

German GDP fell at an annualised rate of 13.4 per cent in the first quarter, after a decline of 9.4 per cent in the fourth quarter of 2008. This compared with a maximum annualised fall of 6.4 per cent in the US. Germany’s recession has not just been much steeper but also much deeper than America’s, with a peak-to-trough decline of 6.4 per cent, compared with 3.9 per cent in the US. And while the US had experienced recessions of comparable severity in previous cycles — for example, a 3.6 per cent peak-to-trough decline in 1958 and 2.7 per cent in 1982 — postwar Germany has never suffered anything remotely similar to this recession.

In the case of Britain, the slump of 5.7 per cent in GDP during this recession has been slightly smaller than the 6.1 per cent peak-to-trough decline in 1980-81.

Second, the unprecedented severity of this recession, especially in Germany, may have caused more permanent damage to the industrial structure not only in Germany but across Europe, than it has in the US and Britain.

Industrial production in Germany has now fallen back to the same level as in January 1991. In America, contrary to the widespread belief in catastrophic de-industrialisation, industrial production is still 41 per cent higher than it was 18 years ago, even after the post-Lehman slump.

The contrast between German and US industrial production is particularly worrying for Europe in view of the structural shifts in the global economy that are almost certain to occur in the years ahead. One way or another, the US is bound to increase its share of world exports as American consumers tighten their belts and the US current account deficit narrows.

The same is likely to be true of Britain. As the Anglo-Saxon countries reduce their trade deficits, their share of global export markets is bound to increase. The question is which other regions of the world will lose net exports to allow this global rebalancing to occur.

This leads to the third reason for believing that Europe’s recovery will be weaker than America or Britain: the persistent strengthening of the euro against the dollar and pound. This malignant hardening of the euro looks increasingly like the mechanism that will ensure that European companies, rather than exporters in Japan or China, bear most of the losses as consumers deleverage while American and British exporters gain global market share.

Europe, fourthly, is actually more vulnerable to deleveraging than generally believed, since German and French companies tend to have more debt than US or British rivals. Meanwhile, government finances, especially in Southern Europe, are much worse than they are in Britain or the US. Germany is particularly dependent on overleveraged consumers in Southern and Eastern Europe.

The idea that German industry will recover on the back of Chinese demand is plain silly, since China and Hong Kong account for only 5 per cent of German exports, while the rest of the European Union accounts for 63 per cent.

Finally, the employment conditions in Britain and America are likely to stabilise quite quickly after the decline in industrial production is over, but in continental Europe unemployment is almost certain to go on rising for several years ahead. European employment has not been slashed in line with production.

As a result, job losses are likely to continue for years after the recession is over, with businesses gradually downsizing their workforce in response to lower production. This is what happened after the 1991-93 recession, when unemployment in Germany went on rising for five years after the recession was over. In the US and Britain, by contrast, unemployment has generally peaked within a few quarters of GDP starting to rise.

The long lags in Europe between production declines and cutbacks in employment result from political and social constraints on both firing and hiring, which tend to make recessions shallower but also much more persistent.

This can be seen in Germany, where the recession of 1991-93 was followed by another recession in 1995-6 and a further near-recession in 1998.

In short, worries about a “W-shaped” or “double-dip” recession should be focused on Germany and the eurozone, not on Britain and especially not on the US. (Anatole Kaletsky, The Times)


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