Hamish McRae: The UK Chancellor may huff and puff but the German one will blow the house down

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The Independent Online

Well it won't, for a host of reasons. The most obvious is that what Mr Brown thinks is less important than what Mrs Merkel does. Her grand coalition should not be written off, though it will have an interim nature. In any case, Germany is reforming its welfare system, and the German economy is the key to European growth. If German growth picks up this will pull up the entire eurozone. If it doesn't, the core Europe will continue to stagnate, though it is worth noting that the latest indicators look better than during the summer.

The second reason is that economics is rarely make-or-break - or even make-or-brake. Slow European growth has been a problem for at least a decade, and the economies have indeed been slowed by the continental social welfare systems. But Europe can bumble along for a few more years yet without catastrophe. Whatever it does to its social welfare systems, the core eurozone economy is not going to sizzle, for reasons discussed below. It would be good to see more progress on reform, and those countries that have been reasonably successful in modifying their welfare systems, for example in Scandinavia, have achieved more reasonable growth. But there is no brick wall ahead; just progressively more difficult times.

Further, while it is true that the UK has grown faster than the big three eurozone economies of Germany, France and Italy, this performance may not continue. Mr Brown has sought to blame the sudden slowing of British growth on the poor growth in Europe, but that does not wash. Lower-than-expected exports to Europe account for only a small proportion of the slowdown. The real reason is the decline in the rate of growth of domestic consumption associated with the end of the housing boom and the widespread expectation of higher taxation. Everyone knows this, so Mr Brown will not find an eager audience for his lectures.

Still, he is right to focus on Europe's welfare pressures and right to point out that these will get worse. A large part of the problem is demography. The left-hand graph above shows some projections for the size of the labour forces of the G7 countries over the next 45 years. The US, Canada and the UK have reasonably encouraging outlooks, but those for Japan, Italy and Germany are dire. France is somewhere in the middle, though the rise in the size of its workforce through to 2010 is an illusion. The chart assumes a retirement age of 65. Because the French retire much earlier than that, their workforce is already about to decline.

These are just projections and events can change the outlook. As Mervyn King, the Governor of the Bank of England, pointed out last week, about half the increase in the supply of labour in the UK has come from migrants from Eastern Europe. A decade ago, when EU enlargement was still a distant aim, that would have been unthinkable. As it has turned out, the influx has enabled the UK to carry on growing, until recent months, at an above-trend rate without showing too many strains in the labour market. We would be in trouble without all those Poles.

Other influences that we cannot plan for will affect the European economies. Nevertheless, the outlook for countries with falling workforces would be disturbing even without a social security system where each generation finances the pensions of the previous one. Most European workers know governments cannot honour their pensions promises, as there will not be enough workers to pay for them. But even funded pension schemes will be under pressure because of the fall in returns. Longview Economics, which developed the graph here, points out that German bond yields are now at a 110-year low due to the excess of savings from the about-to-retire generation.

But demography is only part of the problem. Germany, after all, has five million unemployed out of Europe's 20 million total. While its medium-term problem is that of a shrinking workforce, its immediate one is that it cannot generate jobs for its existing workers. You can understand why Germany, along with most EU countries, refused to allow workers from the new member states to get jobs there.

The main issue is the extent to which welfare reforms would crank up continental European growth rates. Yes, they would nudge at least some of the unemployed towards work. But the problem of lack of domestic demand, particularly in Germany, is deep-rooted. Pushing people towards the job market has little point if they find few jobs when they get there.

This lack of demand has generated a huge amount of debate. It is partly a social matter: why do continental Europeans hold back their spending, while Americans and Britons splurge out? It can't just be a result of different welfare systems or tax levels. It must have something to do with different financial systems, in particular the easy availability of credit in the English-speaking world. But at least the consequences are clear. The experience of the Anglophone world has been that faster growth in consumption creates many more jobs in a wide range of service industries. This is happening to some extent in Germany, but not as swiftly.

This deficiency in demand in Germany, in contrast to the strong demand in, for example, Spain, leads into another question, which I doubt will receive any attention at all at the EU summit. It is not polite to pose it. It is to what extent is the slow growth the result of Germany having the wrong interest rate?

The right-hand chart, from HSBC, shows what has happened to real interest rates (money interest rates less inflation) in Germany and Spain since the euro was introduced. Spain is a relatively high-inflation country so before the eurozone started it had higher real rates to contain inflation. In Germany the opposite applied. Now both countries have the same money interest rate. But because Germany still has lower inflation, that means it has a higher real rate than Spain, where rates are negative. The real rates are the wrong way round. So Germany stagnates while Spain spins ahead.

It would be nice if the European growth problem were simply a matter of structural reforms to the welfare system. Have a problem? Fix it. There are good reasons for wanting to modify the system, not least that it excludes millions of people from the job market. Well-meaning policies can have catastrophic results if they ignore economics. But just as we should not pretend that this is a "make-or-break" matter, so too we should not pretend that fixing the European welfare system is a cure-all for Europe's slow growth.

They mean well, but anti-free traders do the poor no service

The anti-free trade lobby is gathering pace before the World Trade Organisation meeting in Hong Kong, with NGOs such as Christian Aid and Oxfam setting out their reservations about the possible outcome of the talks.

For example, Oxfam's Céline Charveriat, head of its Make Trade Fair Campaign, says: "Issues of vital importance to developing countries are still being ignored. These talks were meant to deliver for development. It's not good enough for the big players to strike a last-minute deal that suits them but leaves poor countries out in the cold."

Meanwhile, supporters of Christian Aid can order their publicity pack, flyers and posters for the mass lobby of MPs at Westminster on 2 November. The purpose? According to the website: "Alongside lobbies being held across Europe and around the world, we are calling for trade justice - not free trade - when the WTO meets in December."

The job of lobbyists is to lobby but to the economist, their rhetoric creates serious problems. One is that attacks on free trade, in the name of fairness, have been used to justify all sorts of distorting policies. The agricultural subsidies of most of the developed world were the result of a desire to protect domestic farmers from "unfair" lower-cost competitors abroad. And there have been social benefits: subsidies have helped preserve rural life in France.

A second objection is that the attacks seem to assume static economic structures. One group of farmers is disadvantaged because of barriers to their exports or because another group can produce the stuff more cheaply. So they should have better access to markets. But actually the better hope might be to shift towards activities with a greater comparative advantage.

But the most powerful objection surely is that the attacks on free trade ignore the fact that post-Second World War trade liberalisation has been hugely successful in human development terms. It created the circumstances where much of East Asia made the fastest advance from developing to developed country status the world has ever known. Similar progress is being made now in much of China and India. Perhaps half a billion people in those countries are visibly benefiting, and many more will. And that is thanks to free trade, not lobby groups.