In September, a fire in the Channel Tunnel meant that Britain’s land link with the Continent was briefly severed once more. For a while it seemed a fitting metaphor for the region’s separate economic fortunes. Britain was doomed to slide into recession, sunk by its over-reliance on finance and an inflated housing market, while the less reckless continental Europeans would be somewhat insulated from the worst of the downturn.
The economic data of the past few weeks tells an altogether different story. Italy and Germany posted a fall in their GDP in the third quarter of this year, following on from a contraction in the second quarter. Statisticians seized on these consecutive declines to proclaim that both countries were in recession. Britain, on the other hand, escaped this ignominy by the narrowest of margins, through having recorded flat growth in the second quarter. It will require a fall in GDP in the fourth quarter before the recession, which arguably began at Easter, is officially recognised in Britain.
Yet Germany and Britain face recession for different reasons. Britain is a smaller, although some might claim amplified, version of events in America. Britain is facing an extended period of austerity and deleveraging as it pays the price for excessive lending by banks to overstretched consumers.
For Germany, which scarcely participated in the great housing bubble by default – most of its households are renters rather than owner-occupiers – the blame for the recession lies abroad. Yet Germany faces a problem not dissimilar to that of China. Both countries are efficient manufacturers and both depend on their export markets. The downturn in the global economy, however, leaves them struggling to find buyers. Already, in Germany, workers’ hours are being cut as manufacturers try to prevent a build-up of inventory.
It could be argued that Germany potentially exports too much and imports too little. To that end, changes in exchange rates can have a useful balancing effect. Some 70% of European Union (EU) trade in goods and 60% of EU trade in services is between EU partner countries. The collapse in the value of the pound against the euro will go some small way in helping to rebalance the economies of both Britain and Germany. Britain needs to export more and consume less, Germany needs to encourage its domestic consumers to consume more.
Less clear cut is what the stronger euro means for Italy. The country is facing its fourth recession this decade. The straitjacket of the euro means that Italy lacks the opportunity for a currency devaluation that might have restored its competitiveness. The goodwill among European bureaucrats is too strong to lead to a breakdown of the euro project, but Italy’s woes demand longer-term reforms that the country may be unwilling to make, such as engaging in the wage discipline that the Germans endured earlier this decade to promote competitiveness.
Nor, for that matter, may the Germans themselves be prepared to repeat this exercise in wage restraint. German unions have been more vocal in pushing for higher wages, citing the eurozone’s recent high inflation rate. Moreover, when banking “fat cats” are rightly or wrongly being blamed for the world’s economic ills, the unions have all the ammunition they need to press for the general workforce to get a greater share of the pie. Until, that is, unemployment rises. In Germany, the unemployment rate is still falling, but this tends to be a lagging indicator, so the unions’ moment in the sun is likely to be brief. This is clear from the Ifo index of business sentiment, which is traditionally a herald of economic direction. As the chart shows, the near term looks challenging.
Fortunately the outlook for the eurozone is not entirely dismal. The European Central Bank has moved away from its hawkish stance and has cut interest rates in response to falling stockmarkets and easing inflationary expectations. A falling oil price should also be a big boon to a region that is a net importer of oil and gas. With the region being less indebted than its Anglo-Saxon counterparts, it is possible that the eurozone could start to see some benefits from lower interest rates, lower energy costs and a less competitive dollar. In fact, France even defied the odds last quarter to record a pick-up in consumer spending.