Hamish McRae: Europe could be such a drag

Europeans have only five shopping weeks to Christmas – five weeks before their francs, marks, lire and so on are taken away and replaced by euros.

Europeans have only five shopping weeks to Christmas – five weeks before their francs, marks, lire and so on are taken away and replaced by euros. Big question: when they get those euros in their wallets and purses, will they save them or spend them?

Here in Britain the debate about the euro has become subsumed into the G&T show – Gordon and Tony. Next Tuesday Gordon produces his pre-Budget statement and gets his brief moment in the sun before the focus shifts back to the PM. The inevitable tensions of recent times broke out last week, with their different views about the advisability of the UK adopting the euro the key grounds for friction.

But if you look from outside Britain, the whole argument looks very different. As an issue, whether we eventually join or not is only just showing on the radar. What matters is whether the euro is a success. If you stand back from the G&T business, that will be the key determinant as to whether we will indeed eventually adopt it. So what do the tea-leaves tell us?

One point should be dismissed straight away: the smoothness or otherwise of the launch. There will inevitably be a bit of a scramble on the Continent in January when the notes and coins start circulating and the indigenous currencies are withdrawn. But the launch will not be a catastrophe at a logistical level and in a few weeks things will have settled down. Expect a clutch of anti-euro stories and expect the currency initially to be unpopular, particularly in Germany. There will be a row about retailers and their suppliers using the new currency to round up their prices. But if the European economy thrives then any initial roughness will be forgiven.

Unfortunately, the short-term outlook has become increasingly discouraging. The politicians who drew up the timetable for the launch of the euro could not have known that it would coincide with the first synchronised global downturn for 30 years.

Last week it was confirmed that Germany was in recession, having suffered two quarters of negative growth. (The April-June quarter was officially shown as zero growth but actually the economy shrank fractionally and the figure was rounded up to zero. The July-September quarter was minus 0.1 per cent.) France was still growing decently in the third quarter, up 0.5 per cent, but is expected to slow in the final one. In the view of J P Morgan Chase there is no doubt: it has just issued a special study with the headline "The euro area recession has begun".

It would be unfair to heap all the blame for this under-performance on the euro, though the reluctance of the European Central Bank to cut interest rates as swiftly as the Federal Reserve may have exacerbated Europe's problems. Nevertheless, if the eurozone economy does worse than the US and UK ones over the next couple of years, it would be surprising were UK sentiment towards the euro to warm much.

In any case, under-performance by the eurozone creates the practical problem that sterling and the dollar are likely to remain strong against the euro. There is a general view that were the pound to join the eurozone it would have to be at a lower rate than at present. I happen to think that view is wrong: that the UK economy as a whole is adequately competitive at the present rate and that its relatively good economic performance demonstrates this. But given the strength of that view, a weak euro does create a practical problem for entry.

Maybe something will happen on the Continent that will lift its economic performance; maybe the pervasive weakness of the German core will be offset by more vigorous growth on the fringe. But there is a danger that Europe will come to be perceived as a generally slow-growth zone.

Some new work by the economics team at HSBC confirms this. Until 20 years ago the eurozone (the European Monetary Union countries) outperformed both the US and, even more dramatically, the UK – as the left-hand graph shows. For the past 15 years the UK has matched the eurozone as a whole and now actually has a higher nominal GDP per head than Germany, France and Italy. But our earlier performance until about 1982 was appalling.

So we have closed the gap, what now? Well, the thing that matters is our capacity to grow – our natural trend growth rate. The HSBC team has gone through the various components that determine growth, from trends in the size of the workforce, its quality, to productivity, entrepreneurship, levels of taxation and so on. It came up with the estimates of trend growth shown on the right. The figure for the UK, at 2.5 per cent, is higher than Germany, France and Italy, but lower than Europe's star performers among the bigger economies, Spain and the Netherlands. (Ireland is the great star, at 6.7 per cent.)

The HSBC team then had a fiddle with the numbers and adjusted the inputs to focus attention on the things that seemed to matter most for growth, with what may to many people seem a rather surprising result. The UK's trend growth rate turns out to be 3 per cent, faster than any other large European economy and topped only by Ireland. If this is right, the UK could do massively better than the eurozone. It may not sound much – 0.5 to 1.0 per cent a year better – but over a decade or two the difference becomes enormous.

We ought to catch some feeling for this over the next three or four years, and such performance, if achieved, will have a profound effect on the euro debate: why bother joining a slower-growing club?

The key variable on the Continent will be whether Europeans spend their new currency. If they do, then the longer-term drag will be less obvious. If they decide instead to keep their euros in the bank – well, Europe's spring could be a cool one.