Hamish McRae: Britain needs a successful Europe but not necessarily the eurozone of today

Economic View
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The Independent Online

It is difficult to separate the substance from the theatre.

The shenanigans in Cannes, coupled with the high drama of Greek politics, give the impression that huge changes are taking place in Europe that will affect us all. That may be partly true but it will take a few days before it is going to be possible to calibrate the mass of new information and determine what is significant and what isn't.

Take Greece. If you are Greek, it is certainly important who is running the show and it is certainly important whether (or how long) the country stays in the eurozone. But there was no new information about the underlying state of the Greek economy or how the country would tackle its problems. Politics hogs the headlines, but we learn nothing new.

Take the eurozone. For the first time ever, European leaders now acknowledge that it is possible for a country to dump the euro. Indeed, Germany and France came close to using the threat of expulsion as a weapon against Greece. But most of us have long accepted that countries can and will leave the eurozone, even though there is no treaty provision for that. How and when that might happen is as uncertain as ever – my own feeling is that this is still some years off – but in admitting to the possibility it may simply be that politicians are catching up with the rest of us.

Or take Italy. For the country to accept surveillance of its economic programme by the International Monetary Fund is a new and necessary way of bolstering credibility. We in Britain might well have found ourselves needing to call in the IMF if the coalition had not got a grip on things quickly. But it is not at all clear that getting a seal of approval from the IMF will have any impact on the substance of Italian life. There is a fiscal problem, and an austerity programme is therefore necessary, but there is also a competitiveness problem, and there is nothing an IMF mission can do about that.

Or at least that is how things look now. If that turns out to be right, then this G20 meeting will be simply more of the same. But it is plausible that it may come to be seen as a turning point, the moment when Europe took a different direction, perhaps moving to a core of northern European countries that retained something called the euro and had common fiscal policies, while the majority returned to their national currencies and retained a "common market" relationship with the core. My instinct is that this meeting is not so significant, but I may be wrong.

What is inescapable is that the European economies are diverging rather than converging. You can measure this in a number of ways. One simple example is to look at Germany's exports. Between 40 and 45 per cent of those exports still go to the eurozone, but, as you can see from the main graph, this proportion has not risen since the currencies were locked together in 1999. If anything, it has tended to decline. By contrast, exports to the emerging nations have shot up, and it is quite plausible that in 10 years Germany will be exporting more to the emerging world than to its European neighbours.

Or take bank deposits. Through the early years of the euro, bank deposits in the fringe eurozone countries rose faster than those in the core. You can see what happened to deposits in Portugal, Ireland, Greece and Spain compared with those in Germany in the small graph. But look at what has been happening now. Money is flowing out of the fringe and into Germany, with the result that fringe eurozone banks are having to rely more and more on the European Central Bank to fund themselves. They are also offering much higher rates on retail deposits.

This may be partly because of a lack of trust on the part of would-be depositors, but it may also be because a "German euro" is ranked as better than a "Greek euro". You know that if the eurozone were to break up, either by Greece going out at the bottom or Germany going out at the top, you would be safer with the German variety. It is simply a common-sense insurance policy.

What is impossible to predict is how these forces will play out. We can be pretty sure there will be a recession in the eurozone. The latest purchasing managers' surveys out at the end of last week are pretty negative, with France, Italy and Spain particularly gloomy.

The split between Germany and France is very interesting. It is happening at an economic level and at a financial level, for the gap between the interest rate France has to pay for loans and what Germany has to pay is the widest since the euro was launched. And it seems to be happening at a political level, too, despite the efforts of the two leaders to present a common front. As Mary Dejevsky wrote in The Independent last week, describing the difficulties the two countries were having saving the euro as a symptom of something bigger: "That something is the start of a change in the political configuration of Europe – a stronger Germany and a more Latin France – that will increasingly define the Continent, whatever the fate of the single currency."

So where might this leave the UK? I think we must accept that what happens on the Continent is beyond our control. Our interest is that our trading partners should be successful. For physical trade, Germany remains our second largest export market after the US, with France number three and the Netherlands four. We have a large deficit with Europe as a whole. But for exports of services, Europe is much less important. Indeed, the latest figures show we are close to a current account balance, the closest we have been since 1997. So while it is important to us that Europe is successful, it is also in our interest that we should seek to diversify our exports elsewhere, as Germany is doing.

In view of the difficulties southern Europe is facing, maybe the lesson of the past few days is that we need to be as nimble as we possibly can be. My strongest expectation is that the UK will escape another recession, but the recent muddles have undoubtedly increased the dangers ahead.

In better news: the eurozone is only 20 per cent of the world economy

Given that the outcome of the G20 meeting seems to be towards the bottom end of the scale of expectations and that the eurozone will be struggling through the winter, what straws of comfort are around?

Well, there were several bits of news last week that, in other times, would have seemed quite cheering. There were OK numbers on job creation in the US, enough to reduce the unemployment rate slightly to 9 per cent. That is desperately high and the progress is "frustratingly slow" as the Fed chairman, Ben Bernanke, said last week. But it is at least moving in the right direction, with the private sector hiring four workers for every post lost in the public sector.

Here in the UK we had better-than-expected GDP figures, but those are backward-looking numbers. More encouraging were car sales, up 2.6 per cent year-on-year in October. Private sales were down, with the squeeze on real incomes, but business and fleet sales (60 per cent of the total) were well up. I suspect that new and much more efficient vehicles coming on to the market are having an important impact on fleet replacement.

Outside the US and UK, there seems to be rising confidence that China, the world's second largest economy, is getting on top of its inflationary problems and will be ready to ease off the brakes. That may not be great for the developed world as a whole – more demand for oil and raw materials – but it maintains demand in the Asian time zone and is a help to Germany and other exporters outside it. What is fascinating is how China has decoupled from the ailing developed world and seems able to rebalance its economy towards the other emerging economies.

You may say this is not hugely comforting, given what is happening across the Channel. But then the eurozone is only about 20 per cent of the world economy. The 80 per cent matters, too.