Hamish McRae: It's a Gallic revival vs Teutonic torpor, with European growth caught in the crossfire

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The Independent Online

The core European economies, those of the original six members, are picking up. There have been a number of hopeful signs in the past fortnight, with the first-quarter growth figures coming through. France grew by 0.8 per cent in the first three months of this year, the fastest pace since 2000. Germany, Italy and the Netherlands all grew at 0.4 per cent - not wonderful but vastly better than in 2003, when all three dipped into recession.

So, sighs of relief all round. After the really dreadful 2003, there is at last some growth in prospect in the main continental economies, with the consensus of economists now forecasting 1.6 per cent growth for this year. That is only about half the figure expected for the UK, and it will not do much to pull down unemployment rates, but it is better than nothing. At a time when Britain has to ponder whether to sign to up to the new constitution and the new EU members have to figure out how to get the best from their new status, the clear political need is for euro- zone members to demonstrate a bit of economic success. The chilling question is: if the eurozone can't grow now, when the rest of the world economy is booming, what on earth will happen during the next global downturn?

Broadly, there are two views on what will now unfold. The optimists look at what is happening in France and suggest that will become more of the norm for the eurozone as a whole. The pessimists point at Germany.

If you are going to France this summer, look around. A sense of spring is in the air. The figures show that both investment and consumption are rising strongly, and you can feel that in the restaurants and shops: people are spending money again. You don't see the army of unemployed - nearly 10 per cent of the workforce - nor do you see the public-sector debts that are being piled up to stoke demand. But the mood holds the prospect of the country growing its way out of trouble.

France's strength is its diversified economy: strong specialist services, a good craft manufacturing sector, smallish but successful hi-tech industries - all this plus a latent cultural protectionist attitude to imports. (Just try to buy Australian wine in a French supermarket.) In France, additional demand from domestic consumers tends to benefit French producers, and domestic demand is now rising.

In Germany, it is different. The growth is coming almost entirely from exports. West Germany at least feels its usual calm and orderly self but the shops are quiet. You get the feeling that people are counting their euros, keeping receipts for anything they can charge to their employers and putting off changing their cars.

The statistics confirm this. Consumption in Germany fell last year; this year it is forecast to stagnate. All the growth comes from exports. You can see this in the charts. GDP has pulled above the zero line (first graph) but retail sales (middle graph) are dreadful, particularly if you include cars, where sales are plunging. I always feel sorry for German car buyers: great roads and the best vehicles in the world but they can't afford them. Instead, they have to be exported to undeserving Americans and Brits. Looking ahead, manufacturing orders have picked up (right-hand graph) but the additional demand is mostly from exports.

What is wrong? The conventional response is that Germany needs lower interest rates. That is the view of the OECD - the organisation of developed countries - and most of the private sector economists here and in Germany. The European Central Bank (ECB) has to set interest rates for the whole euro- zone, not just Germany, and the country needs lower borrowing costs than the rest of the zone. But the rise in rates in the UK and the prospect of increases in the US make it harder for the ECB to move and I'm not sure that even a half per cent off the ECB rate would persuade the Germans to rush out and buy BMWs. The problem is deeper.

General inflation is low (first graph again) but households are being hit by rising charges for healthcare and pensions. Tobacco duty is also going up. So while underlying inflation is only 0.4 per cent, higher health charges and tobacco duty will add nearly another 1 per cent to living costs this year. People feel crunched down.

Business feels ground down too. The medium-sized companies that make up the backbone of Germany's export triumph feel they suffer at the expense of the commercial giants. Big companies get all sorts of help from the authorities and are cutting costs by shifting production to the EU's new members. If you are a medium-sized family company, it is harder to do so.

So which will be the more likely pattern for core Europe: the slow climb of France or the stagnation of Germany?

We will know more by autumn, when we can judge whether higher oil prices will slow global growth. The views of official and private sector econo- mists are split here. The OECD and the International Monetary Fund think the world recovery will broaden from its US/China/UK base to embrace Japan and the eurozone. Japan is already growing fast. The spring IMF forecasts have Germany growing at nearly 2 per cent next year and France at nearly 2.5 per cent.

The private sector is more circumspect. Several City economists think the modest burst of growth this spring will peter out. ABN Amro writes of "policy paralysis" in Europe. The ECB is unable to move as global interest rates rise, so governments will be forced to loosen fiscal policy, which in turn will make the ECB yet more hawkish on rates. The economics team at HSBC also expects the recovery to peak in the middle of this year, though it differs in that it thinks consumption will be so weak this autumn that the ECB will be able to cut rates.

My worry for core Europe is that the problems are really too deep to be solved by either the odd quarter per cent off interest rates or the extra half per cent on fiscal deficits. It is that the European economic and social model, for all its attractive features, has created a climate of non-growth. The underlying capacity of core Europe to grow may be only 1.5 per cent a year, and a lot of that growth has to be diverted into caring for the swelling army of elderly people. So young people entering the workforce may have a lower standard of living than their parents, which is liable to make them even more cautious about spending - particularly in Germany, maybe a bit less so in France. The problem for Europe is that Germany is the bigger economy. Until Germany comes right, even France will struggle.

With a bit of will, transport can take off

The great British transport debate is back in the headlines. The prospect that London's bid for the Olympics will turn on whether it can make sufficient improvements to its transport system by 2008 has sharpened minds on the practical problems we all face getting from one bit of the country to another.

But one part of the infrastruc- ture works exceptionally well: the UK has the most extensive network of international flights in the world and the cheapest regional flights. Not only can we can fly to 80 per cent of the world non-stop from London but, thanks to the budget airlines, we can go to European cities at prices that seem suicidal for the airlines.

The rest is not so hot. A new paper by Stephen Glaister, a professor at Imperial College, analyses what is wrong and suggests ways to tackle our transport troubles. Under-investment is the core flaw, and not just in London and the South-east, though that is where the greatest problems lie. The UK has fewer underground railways that most countries. We have fewer miles of motorway. And, by European or Japanese standards, we have under-invested in railways.

This is not a party political issue. For all the present Government's efforts to blame its predecessors, investment in London's rail network was only satisfactory in the early 1990s under the Major government. Since 1979, we have had three prime ministers, six chancellors and 17 principal transport ministers. The aspect of government that needs the longest-term planning gets the shortest-term ministers.

So what is to be done? Money is needed, some of it from the private sector. Professor Glaister argues for lots of different institutional set-ups. Some of the money can come from the gain in land values, some from higher taxation. New York's bonds, financed by a mixture of charges and taxes, is a way forward. In London's case, the amounts are small relative to the wealth being generated.

So why is this not happening? Partly it is the bad experience governments have had with large infrastructure projects - the cost overruns on the Jubilee line, the low passenger numbers in the Channel Tunnel. But Heathrow's Terminal 5 seems to be on budget and ahead of time, suggesting that what should be changed are management structures. Appointing a transport minister for a full parliamentary term would be a start.