Newswise — For the first time in six years, the gap between real Gross Domestic Product growth in the euro area and real GDP growth in the U.S. is expected to narrow in 2006, according to an analysis released today by The Conference Board, the global research and business membership organization.
"This is occurring thanks to both a moderate upturn in the regions that use the euro and a moderate slowdown in the U.S. economy," says Gail D. Fosler, Executive Vice President and Chief Economist of The Conference Board. This analysis, co-authored with Catherine Guillemineau, Senior Economist at The Conference Board, appears in StraightTalk, a newsletter designed exclusively for members of The Conference Board global business network. "Although the euro-area forecast fails to be impressive at around 2.6% compared with near 3% for the U.S., the cyclical reversal in continental Europe is remarkable."
The question for global capital, currency, and commodity markets is whether this underlying growth momentum can be sustained in the face of slower growth elsewhere. It looks unlikely that the present growth spurt is sufficiently rooted in the domestic European economy to allow growth to continue if the capital goods boom that prompted it slows down. ITALY: 'SICK MAN OF EUROPE'; GERMANY IS ITS ELDERLY PATIENTThe euro-area's growth potential has been generally weak. European fundamentals have improved significantly since the end of 2003, including its two main economies, Germany and France. As early as the second half of 2003, The Conference Board Leading Economic Index (LEI) for Germany started to rise, followed a few months later by the Leading Index for France. The tendency of these two nations and the rest of the euro area to rise and fall together is due to its much increased integration over the past dozen years.
During the past five years, economic performance in both Germany and Italy undermined average growth in the euro area. If Italy could be dubbed the "sick man of Europe," Germany appears to be its elderly patient. But below the surface there are structural changes in German external competitiveness. Especially with respect to France, its main trade partner, Germany's improved cost competitiveness is quite impressive. What appears to be lacking, however, are the permanent productivity-driven improvements that create employment and wage growth to fuel the underlying domestic economy.
GERMANY'S STRENGTH LIES IN TRADE BALANCEDifferences among European economies appear to result primarily from differences in the trends in key performance measures like domestic demand and exports. The shift in Germany's economic performance relative to the rest of the euro area during the second half of the 1990s is due to corresponding changes in domestic demand. By comparison, the pattern of economic growth in France has been very similar to that in other euro-area countries where the structural contribution of domestic demand has been much higher than in Germany.
"Not only are trends in the domestic sectors in France and Germany very different, but so are trends in the external sector," says Guillemineau. "Since 2000, France's export competitiveness has deteriorated badly. The structural contribution of net exports to GDP has acted as a drag on growth. The trend in France's net export performance has fallen well below the other euro-area countries. In contrast to France, where net exports have declined, Germany's growth depends overwhelmingly on its trade balance."
The trend in total exports clearly shows that performance in Germany has been considerably higher than in France and the rest of the euro area. Exports are driven by cyclical factors—namely, world demand—as well as domestic factors.
Also, the structural contribution of exports in Germany from 2000 to 2005 was two-and-a-half times as high as in France and 40% higher than in the other euro-area countries.
Since the late 1990s, export performance has become the backbone of German GDP growth based on dramatic efforts to improve cost competitiveness. As a result, Germany's share in world exports is rising in contrast to the declining market shares among other G7 nations. Since 2003, Germany has become the leading exporter in the world, ahead of the U.S. even. This improvement is all the more remarkable viewed against the backdrop of a strong depreciation of the dollar against the euro.
"But given the importance of export competitiveness to German growth, it is worrisome that the country's manufacturing labor costs remain the highest in the world, partly because of low productivity and partly because of a strong exchange rate against the dollar," says Guillemineau.
AS THE U.S. GOES, SO GOES EUROPEStill, the euro suffers from low external price competitiveness generally and the real effective exchange rate for the euro areas remains unfavorably high. Also, despite wage restraints, there is scant evidence of rising productivity and there is a prospective rise in the value-added tax with which to contend. High oil prices will also dampen household spending on non-energy goods and on services. They may also prompt a steeper rise in the European Central Bank key interest rates than would otherwise occur.
"The slowdown in the U.S. will also affect Europe," concludes Fosler. "Given the absence of a strong internal dynamic driving domestic growth and deterioration in its trade accounts with the rest of the world, Europe is likely to weaken as well."
Source: StraightTalk, Volume 17, #4, The Conference Board
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