Europe Could Overtake U.S. as World's Growth Leader

For further information: Gail Fosler (301) 656-3796
Frank Tortorici (212) 339-0231, [email protected]
The Conference Board

For Immediate Release Release #4455A

EUROPE COULD OVERTAKE U.S. AS WORLD'S GROWTH LEADER SAYS NEW ANALYSIS FROM THE CONFERENCE BOARD

Europe could overtake the United States as the world's economic growth leader next year, according to a report released today by The Conference Board.

While the U.S. economy will continue to grow by a healthy 3.5% in 1999, labor costs, profit pressures, and interest rates could hinder U.S. growth later in the year.

Says Gail D. Fosler, Senior Vice President and Chief Economist of the Conference Board: "The U.S. will continue to perform very well, but fatigue is setting in as labor costs rise and interest rates return to more normal levels. The U.S. economy is not exactly peaking, but rather running along a ridge of high performance spurred by interest rates that are lower than they should be given the cyclical stage of the economy."

But Europe is still in the early stages of expansion, with substantial unused capacity and significant productivity gains likely. Europe also enjoys lower short-term interest rates than the U.S., with long-term rates at or below U.S. levels. Interest rates and falling fiscal deficits are both important cyclical forces spurring European growth.

THE IMPORTANCE OF SERVICES Changes in economic structure also support European growth. The European economy is drifting away from manufacturing toward services. Service sector growth is important to overall economic growth because it offers opportunities for job creation to offset job loss in mature sectors like manufacturing. Service sector productivity, as measured by value added per worker, is also often lower than in manufacturing, producing correspondingly greater employment benefits from service sector growth.

If the European service sector were to rise to 50 percent of all employment by 1999, Europe could add another 4 million jobs. A key issue is whether the European economy can shift more rapidly into services to generate new jobs. Between 1989 and 1997, manufacturing lost four million jobs and private services gained five million. In the U.S. the comparable figures are 1 million jobs lost vs. a gain of 19 million jobs.

"The important question is whether the euro is likely to spur the development of the service sector," says Fosler. "Compared to the U.S., where the private service sector accounts for 73% of Gross Domestic Product and 80% of employment, the European service sector has just broken 50% of GDP and was only 45% of total employment in 1996."

EUROPE LESS EXPOSED THAN U.S. TO ASIAN TURMOIL

An important reason why Europe has not felt the brunt of the Asian crisis is because Europe is much less exposed to the most troubled economies than is the U. S. The distribution of European exports differs from the U. S. in two important ways. First, the largest emerging market for Europe is other developing European countries, while the most important market for the U.S. is Latin America. Second, although Asia accounts for roughly the same share of exports for both Europe and the U.S., only a very small share of European exports are destined for Japan. By comparison, Japan is the second largest export partner of the U.S., accounting for 17% of U.S. exports. The report also notes that the U.S. is more exposed to Asia's economic woes than Europe.

Both European and U.S. exports have slowed along with the overall slowdown in trade, but U.S. export growth has virtually disappeared while Europe's exports are still rising moderately. Even with the collapse of Russia, European exports to lower-income European countries continue to rise because of the persistent domestic economic strength in most of Eastern Europe. Also, because of its sheer size, a recession in Japan is a much bigger drag on the U.S. than Russia is on Europe.

LOWER INTEREST RATE SPUR EUROPEAN GROWTH

The decline in public borrowing in Europe accentuates an already dramatic decline in interest rates. Short-term interest rates are fast converging with those in the lowest-interest rate country--Germany. The long-lead indexes for both France and Germany continue to be quite strong. Long-term interest rates in 11 countries are also declining sharply and faster than in the U.S. Given lower short-term interest rates in the U.S. and a 7% appreciation of the dollar/ECU, Europe has the latitude to cut interest rates even further. A strong currency and what in recent weeks has approached a nearly flat yield curve have put the European Central Bank under considerable pressure to endorse a rate cut. Looking at the "short-leading" indicators that gauge the direction of the European economy over the next three to six months, the only country that is signaling trouble is Italy, where short-term interest rates have recently declined sharply. Source: StraightTalk, Volume 9, Number 10, November/December 1998, The Conference Board

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