Stephen King: Slow growth in Europe's economic old age

'China has played a major role in Europe's disappointing growth over the past couple of years'
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The Independent Online

This weekend may have been politically and socially momentous for Europe, but most of the big changes in the global economy are happening elsewhere. Europe has always been good at "happenings" - the Treaty of Rome, the building and subsequent demolition of the Berlin Wall, the single market, monetary union, and now the huge expansion of EU membership to the east. But it's always been a little difficult to gauge the full impact - if any - of these changes on economic performance. We like to think there should be some effects but, when it comes to measuring them, it's difficult to come up with any convincing estimates.

The creation of the single market in 1992 was supposed to lead to massive efficiency gains, adding a few percentage points to economic growth per year, but since then, Europe has fallen behind in the global growth stakes.

The creation of the single currency was supposed to lead to greater financial stability and, hence, faster economic growth: perhaps it was just unfortunate timing, then, that the euro was formed just as the huge equity bubble of the 1990s came to an unpleasant end.

And the arrival of all these new countries into the European Union will, it is argued, inject much-needed flexibility into labour markets, providing Europe with a competitive edge that, hitherto, has been sadly lacking. Yet, with France and Germany erecting barriers to keep these workers out of their own domestic labour markets, one can only think that this is more a theoretical than practical argument.

So despite all the rhetoric, I'm sceptical that this latest political and social upheaval will make a lot of difference in economic terms. Let's face it, Europe is a region that's getting older and, as it does so, it is losing its appetite for risk and dynamism, two of the key ingredients of rapid economic growth. Most of us become a lot more cautious as we age, and Europe, collectively, is no different. The integration of central and east European countries may change a few things - capital will tend to head east where labour is cheaper, and labour will head west where wages are higher - but the new member states are hardly going to provide the elixir of youth: their fertility rates are, on average, even lower than those of the EU 15.

Europe, then, is not the most obvious starting point for an understanding of how the global economy will develop in the months and years ahead. True, Europeans like to blame each other for a lack of economic progress, as if their destiny remains entirely in their own hands. The European Central Bank likes to blame politicians for a lack of reformist zeal. The politicians, returning the compliment, like to blame the ECB for a lack of flexibility on interest rates. Yet both views are largely irrelevant in a global context. The levers of global economic progress are no longer being manipulated by Europe: it's China, India, the rest of Asia and the US that are dominating the global economic landscape.

Of course, most of us recognise, if not fully understand, America's role in the global economy. Asia, though, is a bit more complicated. A decade or so ago, few economists regarded China as a major influence on global economic activity. It is now. Last year's huge surge in world trade can only be explained - and I stress the word "only" - through an understanding of developments in China. The huge gains in commodity prices over the past two years can also only be explained with reference to China.

If you don't believe me, take a look at why world trade was so strong last year. Most people are happy with the idea that China is a major exporter - the countries that make up the G7, for example, think that Chinese exports are being helped along by an undervalued renminbi, a point that they are happy to make in the now all-too-predictable communiqués that are released after each G7 summit. What is too easily ignored is China's role as a major importer. Last year, Chinese imports increased by about $120bn. This was the biggest single increase in imports of any country, anywhere in the world: bigger than America's, bigger than Germany's, bigger than the UK's, bigger than Japan's and, remarkably, bigger than the rest of Asia's put together.

Because China's imports have grown so rapidly, and because its expansion depends a great deal on the use of basic commodities and raw materials, China has not just lifted those economies that have strong trading links with it. Any economy that happens to depend on exports of commodities for its income - whether or not it trades directly with China - has benefited from the China phenomenon.

China's story has also played a major role in Europe's disappointment over the past couple of years. On balance, Europe trades very little with China. Also, on balance, Europe is a net importer of commodities. So while China's expansion has dragged other parts of the world up over the past few quarters - Japan, other parts of Asia, Australia, some of the Latin American countries - Europe has not benefited from this rising economic tide. Indeed, Europe has simply been saddled with a higher bill for commodities as China exerts its grip on global raw materials. I would strongly argue that much of the upside surprise on economic growth seen in other parts of the world is closely associated with the China story, something that Europe has been unable to take advantage of.

Last week's further emphasis by the Chinese authorities that they intend to slow down China's heady rate of economic expansion is, therefore, a very important message not just for China itself but also for the rest of the world. The countries that have done well during China's boom will now look a bit more vulnerable. Unless they can find some other source of economic growth - more domestic consumption or investment, for example - the global recovery will begin to look a bit more fragile again.

Financial markets are already showing some signs of unease. While the most visible source of concern remains the Federal Reserve and what it is thinking of doing about US interest rates, any China slowdown will also have a critical effect in shaping the world economy.

Equities have been flat since the beginning of the year. Commodity prices, after their earlier strength, have softened and precious metals prices have collapsed. None of this need imply that the global recovery is heading off the rails but it certainly suggests that some of the key foundations of global economic growth are looking rather soft.

Of course, Europe should be immune to any China slowdown - if it wasn't geared into China's boom, it should be less exposed to softer Chinese demand as well.

But for countries elsewhere in the world, there's going to be much more focus on the China story than on the prospects for Europe because, these days, it's China that matters.

Europe, instead, can look forward to its collective retirement, glancing back with nostalgia at its great past economic achievements but looking elsewhere in the world to see the great economic achievements of our times.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com

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