Economics: Europe expects a recovery ... of sorts
Sunday 01 December 1996
On the continent of Europe the questions are all on the other side: they are about deflation. So in France they concern the danger of a slide back into serious recession, and the social pressures this might cause. In Italy, which has perhaps the weakest growth performance of any of the large continental economies this year, they are whether the government can sustain the vigorous fiscal tightening it proposes. In Germany, they are whether the jump in exports this summer and autumn, the only thing providing growth, can continue. And so on.
For the last year most of this economic debate in continental Europe has been Maastricht-linked: what are the implications of this slow growth for the Maastricht criteria? But looking at the figures emerging from these economies, it has struck me that there is something more fundamental going on right across the continent. A long period of very slow growth in consumption is putting continental Europe into the same position as Japan has been in for four or five years: a world of falling prices.
The best place to start is with consumption. It has been very depressed. The graph on the left shows what has been happening to private consumption in the four largest European economies for the last couple of years, plus some Kleinwort Benson projections through to 1998. For each of those five years, assuming the projections are right, UK consumption was or will be the highest. As a result, though inflation is only a touch higher than on the continent (and up to now at least, lower than in Italy), there has been relentless downward pressure on continental prices. Our own producers are upset by their inability to pass on any rise in costs to their customers, but it is a sight worse (or better if you are the customer) over there.
The impact of this is shown on the other graph. Through most of the early 1990s, European inflation was well above US; now it is below it. It is almost down to the level of inflation in the Group of Seven, which is helped by zero inflation in Japan. This is all Europe, by the way: were Britain excluded, the price performance would be even better. Allow for quality improvements which are reckoned to be equivalent to something between 1 and 2 per cent of price rises, and France and Germany have in effect achieved zero inflation.
There will be an economic recovery on the continent next year - you have to be very gloomy indeed to suggest that there won't. But it is going to be completely different in its character from any recovery in memory, and different from the UK recovery. Money wages will increase a bit, but in quite a lot of areas the increase in consumption will come from lower prices. Europe will not be quite back to the situation of the last century, when for many workers much of the increase in their income came in the form of lower prices rather than higher wages, but it will be edging that way. It will, however, be rather like Japan over the last five years, where prices have hardly moved at all. What are the implications of this? Here are several ideas.
For a start, the recovery will be very muted for there will be no pressure on consumers to buy early. As we can see in the computer market, there is the most practical reason for delaying a purchase: if you wait the price may be lower.
If the recovery is more muted because buyers have the option of holding off, it may also be muted because they will tend to save more. Household saving rates on the continent are already high by UK or US standards, but I suspect they will tend to rise even more.
In consumer spending, expect to see quite large shifts between goods and services where prices go up and those where prices come down. There is a smaller perceived difference between a 1 per cent price rise and a 4 per cent rise than between a 1 per cent price rise and 2 per cent price fall. I would expect items like phone calls (where prices are going to plunge) to see a boom, but for there to be repressed demand in big ticket items like cars.
Lower inflation and tighter fiscal policies will, in general, lead to lower interest rates - not just short rates but also long-term bond yields. This will help sustain share prices, and may encourage a recovery in property prices but the benefits of that will only be shared by owners of those assets, not by the general pool of wage-earners. Lower interest rates will, on the other hand, tend to reverse the tendency for European currencies to be over-valued against the US dollar and the yen. One bright spot could well be continental Europe's export performance. We have seen how devaluation has benefited countries like Britain, Italy and Sweden. A lower mark and franc would enable those two countries to sustain export demand, even with flat home consumption, as is happening in Germany at the moment.
In short, yes, there will be a recovery, through the next couple of years, and that will spread quite widely across continental Europe. But, no, it will not feel like much of a recovery for most ordinary workers. And of course the more that some groups of well-organised workers, like the French lorry drivers, are able to garner a larger share of the cake, the more other groups will be squeezed.
How this will play out politically is quite difficult to foresee. In France at the moment there is mounting pressure for a devaluation. It would be astounding if there were not quite serious social discontent in other countries too. The EMU project naturally will be under great threat - even greater threat than it is now. But because that is driven by politics, not economics, prediction as to whether the single currency will occur, in what form, and when, is political guesswork. The key point to grasp is that continental Europe is heading into a time of greater social strain, even if there is a modest economic recovery. Socially and politically Europe needs a spell of rapid growth; it needs to make people feel richer. That is not going to happen in the next 18 months.
If you turn from politics to economics, though, the prospect is brighter. Europe's general global competitiveness will, if anything, be enhanced by a long period of very low inflation and a slow recovery. The restructuring of Japanese companies which has followed the "price destruction" they have endured has made them yet more efficient. The best companies in Europe ought to do well too. German companies have responded swiftly to these pressures following the sharp rise of the mark 18 months ago. But they - and all of continental Europe - need more growth. It would be nice to be able to assert that that is just round the corner. Alas, there just does not seem to be enough of it about.
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