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The Euroland Economy



Running up to Euro-Day

Few people here need convincing that the Euro is a significant gamble. Our own Bank Governor, Eddie George, has made little secret of his worries about the continent's experiment with a 'one size fits all' interest rate policy. But his views are ec hoed - very privately - in the corridors of the Bundesbank, and - not so privately- among the great mass of German economists. 150 of the latter wrote to the newspapers a few months ago urging delay- code for indefinite postponement. A majority of the German people share their views but they were not consulted. As for non-Germans, the economists generally are as concerned but have been swept aside by the politicians wishing to create a united Europe with Germany tightly bound into it. In short, as we all now know post-Lafontaine, this is a political project with serious economic risks.

So how big are those risks and how soon are they likely to materialise? Adam Smith famously observed that 'there is much ruin in a nation '- by which he meant that things could go wrong with an economy for a long time before anything much would change. He could have added that the bigger the unit, the more the inertia and the bigger the ruin. The economy of what will be Euro-land has not been working well for two decades, as can be seen from the chart of its average unemployment rate; and yet the only shift in policy direction one can discern is towards more state intervention and further boosts to public spending - the Lafontaine programme I discussed a fortnight ago. The long-term prognosis for these policies is very poor: German labour costs per hour are double ours and 60% higher than America's. Costs are officially lower in France and Italy but other costs of doing business there may well make matters even worse- their inward investment is lower still than Germany's. In a world of mobile capital an d technology such costs are untenable; when the same productivity can be obtained by applying the same technology to green field sites and when the same capital and raw materials can be obtained at the same prices, why pay more for labour by locating in a high-cost continent? Yes, if only continental skills can be used; but the list of industries where that is true is dwindling with world competition. Yet no less than a third of German employment is in manufacturing- France and Italy are now down to just over a fifth.

There is a striking parallel bwteen Germany and Japan. This too is an economy built on manufacturing excellence, where labour costs had soared by 1995 to well above American rates and re-location (in Japan's case to the Pacific Rim) was seen as industry's answer, so de-industrialising Japan. Unemployme has risen sharply, though the worst has been contained because of social pressures on firms to keep their redundant workers on- so around a quarter of Japanese workers still work in manufacturing. But the policy-makers will not allow the deregulation that would shift people into services as they have in America where only 15% of workers work in manufacturing or even here where it is 18%. Japan has been, in the well-worn local phrase, 'hollowed-out'; but the hollow men have nowhere else to go. Industry keeps them on unprofitably -propped up for the time being by the yen's one third drop since 1995-and services are too regulated to be able to expand and take them on. Tentative moves to deregulate were put on permanent hold when the recession brought on by crass monetary policy in 1989 hit harder and harder.

The world thus has two major rustbelts: in Japan and western Europe. These areas have no chance of long-term revival in the face of the desperate competition from those once-emerging Asians, whose costs are so much lower. Into this grim picture has stepped the Euro. The key problem with a single currency is that the single interest rate cannot address the diverse ('asymmetric') problems of its many states, now the mere 'regions' of Euro-land. In the short term this however may not matter hugely. It would be a great mistake for UK Euro-sceptics to believe in an early crisis. Monetary Unions created with huge political sweat do not break up that easily. Last century's Latin Monetary Union led by France took some thirty years to collapse formally - 'much ruin' again.

Chart of Unemployment in Euroland
In the short term there should be some general recovery on the continent. During 1998 growth in Euroland has been about 2.5%, enough to bring unemployment down from an average of 11.6% to 11.2%. There are signs at present of sharp slowdown; hence the general cuts in interest rates towards 3%, now the Euro's reference level; they should fall further. But worldwide slowdown and excess manufacturing capacity in Asia and now elsewhere too is bound to hit Europe's manufacturing powerhouses particularly hard. The recent history of Japan gives us a clue how badly consumer confidence can react to fears of widespread redundancy and prospective deficits in state pensions.

If the ECB fails to stem the heamorrhaging of confidence, then the worst hit country is likely to be Germany with its huge manufacturing dependence. This is the crucial asymmetry, exacerbated by its very high unemployment, especially in the east. Already we are seeing a new aggressiveness from German leaders over European affairs; this reflects the new priority being given in Bonn to unemployment. The implications for policy in Euroland are more and more regulative restrictions on competition with the German industrial engine from within Europe- accompanied by more early retirement, shorter working hours and so forth in Germany itself. Of course these are the opposite policies to what is needed; and they should put us on guard about our own position were we to join the Euro. But though the difficulties of the Euro will exacerbate the follies of continental policy, the Euro will still be there, causing us and this government continued heart-searching. There is still much ruin in Euroland.

Patrick Minford is professor of economics at Cardiff Business School and visiting professor at Liverpool University.
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