The eurozone is doing all right... not all of it of course, for Ireland has continued to wrestle with its budget this week, Spain is still ground down by unemployment, and Greece by a collapse in demand as well as its much-publicised fiscal crisis. But core Europe, especially the big three of Germany, France and Italy, continues month after month to beat expectations. And because most eurozone countries had their fiscal policies under better control during the boom years than the UK did, they don't face quite such a headwind from budgetary consolidation, aka "the cuts", in the months and years ahead. Why?
Well, credit goes mostly to Germany. Many of the longer-term problems of the eurozone are as serious as ever: the low potential for growth, the inability to offer decent jobs to young people, the difficulties of running a single interest-rate policy for such a divergent region, the debt overhangs, the weakness of the banks – the list goes on and on. Relations between Germany and France are particularly cool at the moment and Germany will baulk at further rescues for weaker eurozone countries. The markets are now clear that Greece will default on its debts at some stage in the next few years. Quite how the European Central Bank, still in wait-and-see mode this month to judge by today's meeting, will cope with a default is hard to predict.
So, lots of problems and they won't go away. But if you look at the strength of the cyclical recovery it is impressive, and here Germany really is the star. The principal reason is that its export industries have benefited massively from the boom in the emerging world. You can see this in snapshots – for example Mercedes-Benz sells more top-of-the range models in China than it does in the US – and you can see it in the confidence of its companies.
The latest Markit survey, out yesterday, conveys this well. Germany and France are still leading the rebound, as you can see from the graph which gives a measure of business activity, with Italy still in positive territory. So more than 60 per cent of the eurozone is still moving forward and while the fourth biggest economy, Spain, is still struggling, that is because of the exceptional blow it has taken after a collapse of its building boom, the same phenomenon that has led to its dreadful unemployment. Construction employs a lot of people. Ireland, also shown, is level pegging, the explanation for that being that exports have offset the still-stagnant domestic demand. But Ireland is a relatively small economy.
The optimism of German companies carries some interesting lessons for the rest of us. Thus there has been a general working assumption that the future structure of European manufacturing will be to keep product development, R&D, design and marketing in Europe but to outsource much of the actual physical production to lower-waged countries in Asia. For some industries that is probably right. Some industries have gone altogether, with not even the R&D remaining. But Germany has followed a rather different path. Partly because of its long-standing engineering expertise and partly because of the structure of its medium-sized enterprises, the so-called Mittelstand, production has tended either to stay in Germany or to be moved to neighbouring countries in eastern Europe rather than to Asia. Of course, there are exceptions, particularly in the largest companies, and manufacturing employment in Germany has followed a downwards trend, as it has elsewhere in Europe. But the pattern has been different from the rest of Europe: more has stayed at home.
This points to a different way of looking at manufacturing: that the idea that you develop products in Europe and then make them in Asia is simplistic. Much of the development of the sorts of engineering products that Germany makes takes place in the factory itself, often with close co-operation with customers, who are usually other German-based companies elsewhere in the production process.
There is a further reason why Germany has managed to do well out of rising global demand, and that's that it has held down its costs. When the euro was launched Germany converted its marks at too high a rate. Its costs were out of line with the rest of the eurozone. But a decade of downward pressure on wages, plus detailed bolting down of costs, has meant that Germany has now become super-competitive, at least by European standards.
Wages are now starting to rise again and this has had a further effect: consumption is climbing faster than at any stage in the past decade. Retailers are more optimistic now than at any time since unification. So Germany faces strong demand from abroad and rising demand at home, a combination that it has not experienced for nearly 20 years.
The effect of this is to pull its trading partners along with it. Austria is showing good growth, for example, and to some extent the French buoyancy is also a function of German domestic demand.
What happens next? There will be several things to look for. One will be the global economy, because that will determine whether Germany can continue to be an engine for the eurozone. I suppose the conventional view here, that we are in the early stages of a cyclical recovery but that there will be some bumps on the way, is probably the right one.
It is too early to say anything much about the economic implications of the new quantitative easing programme in the States, but even on the assumption that the US continues to stage only a muted recovery, German global demand will remain strong. We are going through a strange transition – it is the world market that matters now.
The greatest hurdle for the eurozone will be its own internal tensions: somehow it has to get over those and play to its global role.
Of that, well, I think we just have to accept that there will continue to be uneven signals from the bond markets over the funding needs of the weaker members and that these will hit the headlines. But there is a real economy and a financial market economy. The former will continue to move forward, even though the latter hits the bumps. Medium term, those structural problems have yet to be fixed. Short-term, Germany and the core of the eurozone are doing much better than most of us predicted a few months ago.Reuse content