Brad Setser makes me think ...
... as he invokes Europe as a driver global demand growth pointing to the upswing in European imports (ECB press release) in the past year compared with USA. Brad Setser's begins departs from those global imbalances and whether, when, and how they will unwind. The logic is that as growth slows in the US the CA deficit will shrink and other regions (Europe, Asia, and Petro-exporters) will begin to build up their imports. The most important point here is that all these issues are intimately inter-related with for example all the talk recently about the US slowdown and whether the rest of the world can de-couple from a US slowdown.
Following the logic above this would mean that as the US economy slows down and the CA deficit shrinks other regions pick up the pace and start building up CA deficits of their own and this is where Brad Setser begins; Is Europe for one ready to take over the torch here? I have argued several times that this is very unlikely and that whatever way we look at the US economy; its slowdown will affect the rest of the world because there in fact is no one to take over in the short and medium term. But then Brad hits me with this chart of growing European imports and I this obviously makes me think ... have I been overtly tough in my narrative of the Eurozone economy? So how should I play this one?
First of all I would like to cite a commenter from Brad Setser's post ...
'On to the larger point: it is very important to shower skeptics with solid evidence about European economic performance. I am not uncritical of the various Euro-models myself, but I think an ideological blindness has taken hold. Economic theory says competition is the ultimate good; European institutions limit competition; therefore Europe must be sick and in need of competitive therapy.'
Although I do not feel particularly hit by this criticism there are some important points here. We do not want to be stuck in our respective ditches here and should the Eurozone pick up the pace and power ahead to take over where US is seemingly letting go I will be the first to concede and praise the ECB for its efficiency in guiding a very diverse economic entity as well as I will praise the governments of Italy, France and Germany of making badly needed reforms. However, sadly I do not think it will come to that. So I will play this one very much as an ostrich hiding my head in the sand and repeat myself. Let us take the important argument first ...
1. The diversity of the Eurozone
Remember we are talking about the idea of global imbalances here and US as the world's largest economy. This should be compared to the Eurozone where I think that we might want to consider whether we want to think of the zone as one single economic entity in this global imbalance scenario? I mean, as it is also noted in the comments section of Brad's post there exist major imbalances within the Eurozone where for example Germany is running a current account surplus and France and Spain running deficits. This means that the Eurozone's largest economy is running on exports which are bound to go down when the US slows and France and Spain's current account deficits are fuelled by housing bubbles although France looks much more solid here. I won't even mention Italy and Portugal here since their compliance with the demands of convergence will likely have ugly deflationary side effects or they can opt out of course and use the good old devaluation tool. All this is simply to say ... at what point in time will we see the combined Eurozone countries spend and save in the same manner? In order to anwser this we go to point 2 ...
2. Demands of convergence/growth and stability pact
This is all well and good in theory. If just all countries would stay to the fiscal targets the idea of ECB single interest policy would make sense and all Eurozone countries would eventually converge to the same trend path of growth. I am not sure this will ever happen but even if this grand scheme should work at some point I would be the first one to welcome it. In any case we are not there yet and it will take some time before we arrive at the point where we can speak of the Eurozone as one single economic entity. This brings us to number 3 ...
3. The road ahead?
What will it actually take for us to get there? In one single expression ... it will be a bumpy ride. All major Eurozone countries are struggling with fiscal deficits and debt levels above the Maastricht criteria. Some will weather the storm better than others but someone is bound to be left behind. Another way to conceptualize this is through demographics ... Look at Italy and Germany both with ageing populations and comparatively low TFR rates ... where is the growth to come from if these countries have to converge with tight fiscal policies and a hawkish central bank on their backs? Incidentally, the whole idea of convergence is in many ways highly unlikey if we look at the Eurozone's different population structures; I mean there might be a very sound reason as to why Germany is not seeing any sustained domestic demand (running on exports) and why Spain is running a current account deficit fuelled by a credit booming housing market.
In the end, I am so very sympathetic towards the Euro as a poltical project and I would love to see a tightly integrated Europe but as an Economist I just keep hitting my head against a brick wall; something just does not work here.
Finishing off with Brad Setser's view I resume my ostrich position. However, if the data keeps on going in the direction Brad is so rightly pointing to I will have to pull my head up from the sand and do some serious remodelling of the way I am looking at this.