Economic View: When the growing gets tough

Providing the message about Europe is larded with commiseration and charm, it is just possible that the call for 'structural reform' might have some effect

So what are you doing for world economic growth? That question will, according to Gordon Brown, be posed this weekend at the annual International Monetary Fund meeting in Dubai to each of the main economic powers: the US, Japan and Europe. It is important for the developed world to address this issue, to help maintain the momentum that might otherwise be threatened by the failure of the trade talks in Cancun.

So what can the different countries offer at what should, the Chancellor believes, be a "structural reform summit". The US might reasonably claim that it has already done a huge amount, though it has to be sure its corporate reforms stick. Japan could for once claim that it is growing at last, though it faces huge banking reforms. But what can Europe say? It is the weakest link.

Mr Brown's view, set out in an article in The Wall Street Journal last week, is that Europe has to embrace a growth agenda. This would include labour market reforms, liberalisation of financial markets, elimination of wasteful state subsidies, favouring tax competition rather than tax harmoni- sation, and deregulating where possible.

In a key sentence, given all the more resonance by the Swedish vote on the euro, he writes: "As long as Europe clings to the view that the euro will be followed by a federal state, confidence will be low."

Whether you agree with him or not, the Chancellor must surely be right that Europe holds the key to faster world growth. The US economy is picking up speed at the moment with the leading indicator of the Conference Board, the American research organisation, rising further in August. This suggests there will be good growth for the next six months.

Beyond that? Well, the US may have made a start on the big adjustments it will eventually have to carry out. Those twin deficits of current account and Federal budget are still widening, but the lower dollar seems to be pulling up US exports, and in particular exports to the eurozone (see first graph).

Improving export performance is the key to keeping the current account deficit at an acceptable level - acceptable, that is, to the holders of dollars. Indeed one of the greatest single threats to world growth next year would be a sharp fall in the dollar. It would give a boost to the American economy, but with collateral damage to the rest of the world.

Japan, the seemingly perpetual laggard among the developed countries, seems at last to be showing decent growth - and domestically driven growth too (see next graph). The economists at the US bank JP Morgan note that Japan has come through a period of weak global demand and fiscal tightening to grow more rapidly than the US in the first half of this year. It thinks, too, that recovery will continue. Japan as the star is a new and surprising turnabout.

And Europe? The disturbing thing is the way the eurozone keeps undershooting the forecasts. It has disappointed the official forecasters of course, but even the private sector ones keep getting Europe wrong. JP Morgan has charted the gap between the consensus forecast the preceding September and the actual out-turn for both the US and the eurozone. The results are shown in the third graph.

In the past 11 years there have only been three times when the eurozone (or its main members prior to the introduction of the euro) did better than forecast. In the other eight it did worse. In the US, by contrast, there were seven years when the US did better than forecast and only four when it did worse. The eurozone only beat forecasts in years when the US also beat them, and then not by as large a margin.

It is hard, given this record, to be confident that the eurozone will beat the present forecasts for next year of 1.7 per cent growth. (Last September, the consensus was 2.3 per cent this year, and the out-turn looks like being about 0.5 per cent. Ouch.) So what will happen?

It is not realistic to expect "old" Europe to adopt the Chancellor's agenda to any radical extent. The political will is not there, and understandably so, for things are not bad enough to force rapid change. In any case, there are fragile elements in the UK position, and in particular the dependence on consumer borrowing to sustain demand.

Besides, there are elements of reform taking place in both Germany and, to a lesser, extent in France. Take tax competition. Well, Germany plans to reduce its top rate of income tax to 42 per cent, only a whisker above our 41 per cent top rate. France, too, is cutting income tax bands. True, other taxes are higher than in the UK but these cuts are a start. Last week, meanwhile, the two countries came up with joint proposals to develop hi-tech products that would boost the economy.

One function of the IMF and World Bank meetings is to get the finance ministers together. When they do, they usually find they have more in common than they might expect: finance ministries around the world have similar problems, including tricky relations with prime ministers or presidents. Providing the message that Europe is the weakest link is suitably larded with commiseration and charm, it is just possible that the call for a "structural reform summit" might have some effect.

That is certainly the thing to look for. Finance ministers have to work in the real world. They are stymied by domestic politics and cannot do anything for the poorer nations on agricultural trade. But they might be able to take steps to grow a bit faster and so become better markets for other goods. On the other hand, as Kenneth Rogoff, the IMF's chief economist, said last week, that might be asking too much: "For the moment, most Europeans who want to see an economic recovery will have to watch it on TV."

Comments