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Europe, Engine of Global Growth

by TGeraghty Mon Aug 28th, 2006 at 11:58:05 AM EST

Brad Setser has a unique way of looking at the importance  of the European economy to global growth:

Europe, engine of global demand growth

That isn't a headline that you see in mainstream economy commentary.    The standard story - one that is echoed in communiqué after communiqué - goes something like this.

Global rebalancing - code for a set of changes that will slow demand growth in the US and increase demand growth outside the US to help reduce the US deficit and the rest of the world's surplus - requires policy changes in Asia, the US and Europe. . . .

What does Europe need to do contribute more to global demand growth?  Reform its labor and product markets.  It hasn't done so.  So it won't be able to contribute to global rebalancing.  

One problem.  The story isn't true.   Not right now.   Europe may not have reformed.  But it sure has contributed to global demand growth over the past year and a half.   My evidence? European imports.

Imports are the most direct way Europe contributes to global demand growth.  And they are way, way up. . . .

Promoted by Colman

Eurozone imports have increased even faster than those of the US:

China's exports to Europe are growing even faster than those to the US:

It isn't all oil either.  China doesn't export oil.  And European imports of Chinese goods are growing faster than US imports of Chinese goods.

Could it be that lack of "reform" is actually promoting European growth rather than inhibiting it?

The facts are pretty clear.  Europe has delivered a big impetus to global demand over the past 18 months.  Despite the absence of the labor market reforms proscribed by the great and good gathering at Jackson Hole.

Or maybe because of the absence of the proscribed labor market reforms - their impact on demand growth has never been all that clear to me.   If more job uncertainly leads to more savings (and if labor market liberalization leads to downward pressure on real wages in some sectors ... ), the overall impact on demand growth is ambiguous at best.  And I doubt European firms are pushing hard for labor market flexibility because they are desperate to raise wages faster than the rigid unions will allow.  The link between labor market reform and demand growth seems pretty thin to me, at least in the short-run.

So, smooth sailing for the Euro economies? Nah!

Housing market froth - thank you Spain and France - seems far more correlated with demand growth than labor market reform.  Combine housing market froth and a relatively strong currency also helps pull in imports and, well, you get Europe over the past 18 months to a year. . . .

. . . Europe's mini-boom may be ending.    The data is contradictory. Some German business confidence data is encouraging; other German business confidence numbers are not so encouraging (hat tip, Claus Vistesen).   The same forces that pulled down the US housing market may eventually hit Spain and France.

As Laurent pointed out in the breakfast thread it's not clear that in France or in Spain it's really possible to extract equity from houses in quite the way one can in the US, UK or Ireland.
by Colman (colman at eurotrib.com) on Mon Aug 28th, 2006 at 11:57:34 AM EST
And let's add that Germany hasn't had any housing froth at all.
by afew (afew(a in a circle)eurotrib_dot_com) on Mon Aug 28th, 2006 at 04:09:48 PM EST
[ Parent ]
But that's just a small regional economy.
by Colman (colman at eurotrib.com) on Mon Aug 28th, 2006 at 04:10:51 PM EST
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Minuscule ! :)
by Laurent GUERBY on Mon Aug 28th, 2006 at 04:14:10 PM EST
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I semi-snarked, so I'll do it again.

Is this cyclical effects at work?

Setser certainly presents it as so, basically we're following the same path in increasing imports from China that the US did, just later on. Sounds a lot like the delayed effect where IT investment started later in Europe and so the "productivity gains of IT" came through later than the US too.

by Metatone (metatone [a|t] gmail (dot) com) on Mon Aug 28th, 2006 at 03:34:07 PM EST
You'd need a much longer time frame for EU import/exports to conclude. You can ask Brad, he often answers and provide more data.
by Laurent GUERBY on Mon Aug 28th, 2006 at 04:15:09 PM EST
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Actually, the reason it's a semi-snark is that it's an unprovable. Even if the effect is "semi-cyclical," every economy is a superposition of cycles, just as any signal wave is a superposition of simple waves.

Trouble is, since we don't know what half of the various cycles are, the fourier goes muddy.

by Metatone (metatone [a|t] gmail (dot) com) on Mon Aug 28th, 2006 at 04:32:14 PM EST
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You're undermining the exact science of economics again, metatone.

you are the media you consume.

by MillMan (millguy at gmail) on Mon Aug 28th, 2006 at 04:55:52 PM EST
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Terrible, isn't it? Obviously I need to report to the re-education camp.
by Metatone (metatone [a|t] gmail (dot) com) on Mon Aug 28th, 2006 at 05:07:28 PM EST
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When the Fourier goes muddy, you're supposed to mention wavelets and look profound and professorial.

(Apparently this works in engineering and physics too.)

by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Aug 28th, 2006 at 07:05:57 PM EST
[ Parent ]
I thought Setser might back up the housing froth claim with some solid data, but nope. As Laurent pointed out, it's not easy to turn housing equity into quick credit in France and Spain, and, as I pointed out, Germany isn't involved in housing froth. And why would a "wealth effect" from a property boom that has been going on for some years only translate into higher consumer demand over the last 18 months?

So I'll go along with Metatone and say:

by afew (afew(a in a circle)eurotrib_dot_com) on Mon Aug 28th, 2006 at 04:33:38 PM EST
I've asked him:

"(spanish and french housing bubble) deflates. that will slow their growth,"  

I don't know about Spain, but I still don't see how the french housing buble deflating will have major effect: french cannot use their house as ATM, construction jobs are not as big as in the US, fixed rate loan are still the overwhelming majority and were taken in a very low fixed rate context (okay they're longer maturity than previous decades but that's about it).

I'd appreciate any insight you have on the french situation.

Thanks for this great post!

by Laurent GUERBY on Mon Aug 28th, 2006 at 05:36:15 PM EST
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I didn't follow it closely, but wasn't some proposals from the UMP or the government making the round for allowing to use  house-equity for backing consumption loan?

Anyway, "quand le batîment va, tout va", and I believe it is a main reason why the growth in France or Spain is so positive. I'm not sure you can't call it a froth in France. The prices went up across the board. Plural of anecdotes is not datas, but people I know are quite frenetic about investing in houses with the low interest rates we had.

Maybe they feel the ECB won't allow it too long. One wonder why ;-)

La répartie est dans l'escalier. Elle revient de suite.

by lacordaire on Tue Aug 29th, 2006 at 05:45:44 AM EST
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Yes the law is there since a few monthes ago but no commercial I know of yet.

There's no question that prices went up in a bubble fashion, just about what will happen to consumers and the economy when they go down or flat for a while.

by Laurent GUERBY on Tue Aug 29th, 2006 at 08:36:04 AM EST
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And about precisely how rising property prices have fueled consumer demand only over the past 18 months...
by afew (afew(a in a circle)eurotrib_dot_com) on Tue Aug 29th, 2006 at 10:19:15 AM EST
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Brad answered:

Laurent, I am not an expert on France, but Daniel Gros's work convinced me -- atm or not -- the wealth effect from rising housing prices seems well correlated with rising consumption/ domestic demand led growth and current account deficits in europe.

Now I have to look after more data :).

by Laurent GUERBY on Tue Aug 29th, 2006 at 01:48:44 PM EST
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As setser says, Europe is paying its imports with real money. It's true with China, and it's true with oil producers:

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Aug 28th, 2006 at 06:16:45 PM EST
Only the USofA gets a credit card.
by Richard Lyon (rllyon@gmail.com) on Mon Aug 28th, 2006 at 06:27:33 PM EST
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The papers does not mention France, the figure Brad refers to is probably Figure 4 page 6, which is using proxyes, not very convincing to me.

by Laurent GUERBY on Tue Aug 29th, 2006 at 02:07:28 PM EST
Gros's interest is in a direct comparison witht he US, and to that end he averages out Eurozone house prices and says they are following US fairly closely. This is what he says about the economic effect of the rise:

The key reason why US housing prices have attracted so much attention is that a property price
crash or just a deceleration of the rate of increase of housing prices in the US would almost certainly weaken private consumption through wealth effects and ncreased uncertainty about the economic outlook. This is well known, but the data presented here imply that the same
danger exists for the euro area. In the euro area, the wealth effect might be less strong and consumers might be less indebted, but a fall in housing prices could instead also lead to an abrupt fall of new construction investment. Moreover, a fall in housing prices may jeopardise a part of the outstanding loans of the banking sector and force banks to raise reserves. This could reduce their willingness to extend credit to businesses and consumers. While the exact details of the transmission mechanism are different on the two sides of the Atlantic, it is clear that both sides face a quite similar risk.

Substantially, he's saying there would be:

  • a drop in contruction investment;
  • tightening of credit;

but not:

  • a hit on the "wealth effect";
  • a consumer debt problem.

I don't see how that is equivalent to a "quite similar risk".

He also doesn't address why consumer demand has only risen recently, while the property market has been booming for some years.

by afew (afew(a in a circle)eurotrib_dot_com) on Tue Aug 29th, 2006 at 02:39:28 PM EST
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I've posted links to graphs of french data on Brad's blog:

Brad, Daniel Gros doesn't mention France, and I find his proxy graph (only data point where France is) unconvincing.

When I look at first page of this document from Credit Agricole, there's a consumption growth graph 1995-2006 for France:


It was 4% growth during 98-2000 stock buble, but since then it went down to 2-2.5% a year.

About housing prices, still from Credit Agricole, page 2 there's a housing price graph for 1995-2006:


I find no obvious correlation with consumption growth in the French case.

No plausible mecanism in the french case and no correlation in the french data.

We'll see what the future holds :).

by Laurent GUERBY on Tue Aug 29th, 2006 at 03:32:51 PM EST
[ Parent ]

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