A view from London
There are reasons for optimism about the US, but there are also risks.
Ian Stewart
Europe’s economy seems to have turned the corner. In the first quarter of this year, the economy expanded by 0.3%, the strongest reading in a year and enough to lift the region out of recession. This doesn’t look like a flash in the pan. Economists expect the EU to keep growing this year and through next.
With inflation down to 2.4% in April, and underlying or core inflation running well below US and UK levels, the European Central Bank is likely to be the first major central bank to cut interest rates. Markets ascribe a 93% probability to the ECB reducing rates when they meet on 6 June.
A return to growth ends a miserable period for Europe. The pandemic, soaring inflation and the energy crisis have hit the region hard. Excluding Ireland, whose GDP data are flattered by the treatment of multinational companies’ profits, the EU economy is only 3.0% larger than it was in 2019. Over the same period the US economy has grown by 9.0%.
American economic outperformance against Europe long predates the pandemic. Among economists, optimism about Europe’s recovery is tempered by worries about the region’s long-term growth prospects. This came through to me last week at a conference of US and European economists held at the Bundesbank in Hamburg.
In some respects the mood of optimism about the US economy reminded me of the near-euphoria about US growth prospects during the dot.com boom of the late 1990s. Speakers cited a number of factors that they believe will contribute to a superior US performance over coming years.
Cheap home-grown energy from oil, gas and renewables gives America a cost advantage over Europe. In Europe, the natural gas price is currently about four times that of the US. The average baseload cost of electricity over the last month in Europe was $73/MWh, twice what US consumers pay. Europe’s chemicals sector has been buffeted by high energy prices, with plant closures, which seem set to continue this year, and some producers shifting capacity to lower-cost countries, particularly the US.
Government spending is fuelling the US recovery, with a vast programme designed to rebuild infrastructure and transform the semiconductors and renewables sectors. Fiscal policy is running far looser in the US than Europe, with a federal deficit forecast by the IMF at 6.5% of GDP this year compared with the euro area’s 2.9%. Crucially, the US is easing fiscal policy, further boosting growth, while the euro area is tightening.
A number of speakers at the Hamburg conference argued that government spending, tax breaks and subsidies would reinforce America’s lead in the development and deployment of technology. It’s a big change from the consensus view 20 years ago, but my sense is that economists are warming to the sort of high-spending industrial policies, deficits and protectionism practised by the current US administration.
Demographic factors favour the US too, with high levels of immigration and a slower pace of ageing conferring a growth advantage over Europe. The UN estimates that by 2030 America’s working-age population will have expanded by 3m people while the EU’s will have shrunk by about 10m.
The hard data paint a generally rosy picture of the health of America’s economy. Investment spending is booming, with the share of GDP accounted for by investment in the last ten years close to the highest since the war. Growth in investment, bolstered by government support, is particularly strong in manufacturing, computers and electronics. Business formation is surging. Levels of R&D spending, venture capital raised and patents far outstrip the EU. All of this bodes well for future growth – and a widening of the already sizeable gap between the US and the euro area. (The average euro area worker produces roughly 80% of what an average US worker produces in an hour.)
There are reasons for optimism about the US, but there are also risks, of which there was less talk in Hamburg last week. The record of government intervention and industrial policy in the US is mixed. It is hard to believe it will be different this time. History and economic theory show that protectionism raises prices and weakens competition, often to the detriment of long-term growth. Easy fiscal policy, coupled with an ageing population, means US debt will soar over the next 50 years, creating a new source of vulnerability.
That said, I would guess vanishingly few economists think Europe will even come close to matching America’s growth performance over the next ten years. Europe needs new sources and drivers of growth. An obvious place to start would be by doubling down on economic integration within the EU to build a larger, more competitive market closer to the US model.
The 1990s and early 2000s saw rapid economic integration in Europe, with the creation of the single market, the euro and EU enlargement into central and eastern Europe. That period ended with the financial crisis. Now, with growth coming back in Europe, would be a good time to restart it.