What really strikes me about the slowdown we are currently seeing in the eurozone economies is not so much what we are seeing, but how we are seeing (or if you like interpreting) it. The core of the issue is to be found - as is ever the case - in the details. And first and foremost among these details is the way in which inflation is so obviously crimping any attempt on the part of the ECB to use conventional monetary policy (namely lowering interest rates) to help the ailing Spanish (see here) and Italian (see here) economies. As a result the Sabre rattling continues in Frankfurt and the euro continues to move onwards and upwards, touching an all time high of $1.6019 yesterday (for a fuller exploration of some of the issues which arise here, see Claus Vistesen's recent The ECB - One Play-Book, One Page, One Purpose post).
It also doesn't seem to me to be without some significance that what sent the euro off upwards again yesterday was a comment from French Central Bank Governor Christian Noyer.
“Our big problem is to ensure that inflation returns below 2 per cent next year,” Christian Noyer told French radio. “If needed, we will move interest rates.”What Noyer seems to be saying is that the French economy is weathering the storm, not only were exports up in February, but unemployment continues to fall, and industrial output continues to surprise on the upside, while the French services sector remained the one bright spot on an otherwise darkening eurozone horizon, at least according to the March reading of the Royal Bank of Scotland purchasing managers index. So it is the underlying strength of the French economy at the present time which is the real news behind the headlines of the record euro level we saw yesterday.
In fact the substantial appreciation in the value of the euro (which should have some kind of disinflationary pass-through impact) may well make an actual rise in ECB interest rates unlikely in the near future, but it is interesting to note that - in a significant turnround - the financial markets have started to price-in the slight possibility of an increase in ECB rates later this year. The ECB meanwhile mainatins the posture that the economic uncertainty surrounding the current outlook makes the direction of its next interest rate move unclear.
What really caught my eye this morning, however, was the following comment in the Financial Times:
France’s economic outlook could play an important role in the ECB’s thinking. Spain is facing a sharp housing market correction, while German economic growth is thought to have been surprisingly strong at the start of the year. “The fact that France is holding up in the middle is probably preventing eurozone [economic] numbers from moving significantly to the downside. It is a bit of a buffer,” said Jacques Cailloux at Royal Bank of Scotland.
France may be a bellwether for the eurozone because its relative resilience lies in the absence, so far, of a credit crunch or sharp slowdown in consumption.
Basically what is strange about all this is how it is precisely the French economy (in terms of the durability of its domestic consumption) that is really holoding things together in the eurozone right now (along with German exports - but NOT German consumption - of course). What is most striking from where I am sitting is how little thought all those big-name widely-quoted economists seem to be giving to the implications of what is happening. Claus Vistesen and I would argue - naturally - that the apparent resilience of the French consumer (how can I keep my head, when all around me are losing their's) has someting to do with France's comparatively favourable demographics. But perhaps others who do not share this view would also like to offer some sort of explanation - for reasons of intellectual self-respect if for no other reason.
Basically I find it hard to see - if I follow the standard explanations - how it is that an economy that everyone has spent the last five years or so trashing - for its labour market inefficiencies, its profligate government spending and its high level of state intervention - turns out to be doing just fine (or nearly so), while all around are starting to visibly wilt.
Obviously there is more to this story than simple demographics. The French banking system didn't invent its own version of the Spanish "cedulas hipotecarias", and wasn't offering such a huge percentage of variable mortgages, and wasn't offering so many 100% (or 110%) Loan to Value mortgages. That is the French banking system seems to have been more (or better) regulated (and that used to be a dirty word), and as a result isn't facing any imminent danger of fiancial meltdown since - desite having the same nominal interest rate as Spain - French householders were not sent of on a "buy one, and buy a second what while you're at it" housing spree of anything like the proportions which we have seen in Spain and Ireland. But again most commentators don't even seem to be even picking up on this part.
The roots of this recent renaissance of the French economy in economics discourse in fact go back to the autumn of last year, when the Financial Times ran a rather interesting story (see my original blog post here) which pointed out that:
"The size of the British economy has slipped below that of France for the first time since 1999 thanks to the slide in the value of the pound. Sterling’s rapid fall to 11-year lows against European currencies has also pushed Britain into sixth place in the world. The US, Japan, Germany, China and France all had larger economies than the UK in the third quarter of 2007."
Basically the facts behind the story are that in 2006 French GDP was worth €1,792bn compared with £1,304bn for the UK. With sterling worth €1.47 on average in 2006, this put the UK economy comfortably 6.7 per cent ahead of the French one. But with sterling on the slide - it has fallen by more than 10 per cent against the euro in the past six months (to the current €1.32 to the pound), the UK economy entering 2008 is now 4 per cent smaller than France's.
And again there is a bigger picture story behind the headlines here, one that has to do with the fact (as Claus Vistesen tried to sketch out here) that France, far from being the "sick man of Europe" in economic terms, and as a result of some very important underlying macroeconomic structural features, is now enjoying a new lease of life.
This view must surprise some people, since it is obviously a long way away from a lot of conventional wisdom which is being written on the matter. Basically, if you follow the institutional reforms discourse, then the UK should be streaking ahead of France following the latters failure to grasp the nettle and "reform" itself (something, please note, that the present author considers highly desireable in and of itself). But such reforms only focus on micro level phenomena, and do not take into account certain key macro economic trends, and in particular they seem almost never to take into account important macro level phenomena like comparative demographic shifts. What this means quite simply is that something here isn't being measured as it should be, and the outcome is bad results and bad forecasts.
This use of bad arguments (or at best partial ones) also makes it very difficult to persuade some people - in this case French voters - to do something that they are evidently very reluctant to do, and that is support the reform process. When your key argument is flawed, and you can't point to the benefits you would like to point to (even if in fact many of the reforms being proposed are quite necessary, especially in terms of the long term sustainability of the health and pensions systems). This peculiar situation was also recently highlighted by the move of those eternal "bette noires" of the international financial institutions - Argentina and Thailand - when they complained only last year to the world bank that since the normal "competitiveness" indexes were giving them very bad ratings, while at the same time their economies were putting in strong performances, then there must be something wrong with the indexes. I imagine they are still waiting for a coherent reply.
Basically the whole "institutional reforms" story is wrong, not because such micro level competitiveness-oriented reforms are unnecessary (they normally are), but because they are only part of the picture, and thus offer a very misleading perspective. A classic example of what I am talking about was also offered by the Financial Times's recommendations to Spain on how to solve the economic mess which the Spanish economy is now headed towards (incidentally, I would point out here that I have nothing against the Financial Times, and I am simply quoting their correspondents since they form part of what I consider to be a much more general problem..
Spain has been content to enjoy the benefits of cheap credit and strong European demand for its goods and services. Unlike France, it has not embarked on the structural reforms needed for longer lasting prosperity.
Mr Zapatero pretends these are not needed. But, if re-elected, he should rethink. Generous tax cuts should be avoided in order to maintain a mildly restrictive fiscal stance. Measures to foster competitiveness are essential. These should include dismantling barriers to competition in retailing, transport and energy. He should ditch a preference for national champions.
Persistent weakness in productivity growth must be addressed too. Recent steps to expand Spain’s small technology base, promote entrepreneurship and bolster its ossified education system are positive. But universities need more independence. Allowing companies to opt out of collective wage deals would make the labour market more flexible. This is far from a comprehensive manifesto. But it is the least Spain must do if it is to remain one of Europe’s pacesetters
Now I think we could pass quietly over the little detail that France is now being cited as a country which is benefiting from structural reform. What is notable about the kind of "rescue package" being proposed for Spain is that it is largely ignores the substantial underlying macro economic questions which are in play - like the health of the banking system, some evaluation of the impact of "financial efficiencies", interest rate policy at the ECB, the value of the euro, the presence of five million immigrants (who have largely arrived over the last 6 or 7 years at just the same time as the current account deficit - which the FT does mention -has balooned), the role of the eurosystem and covered bonds in making cheap interest loans available at what were effectively negative real interest rates, etc, etc, etc.
Evidentaly non of this is directly Mr Zapatero's fault, any more than it was Mr Aznar's fault. This is not the moment to attempt a fuller analysis of Spain's current problems - you can find a first attempt at getting to grips with these here. Rather my objective is to point out that basing yourself on micro economic analysis alone you will never get to the heart of major economic issues which face us. And this is what the current mainstream economic discourse seems to do, spilling in the process an excessive amount of ink about shop opening hours, flexible labour contracts, and privatisation of "national champions" (all of which, please note, may well be a good idea, but I can tell you now, none of these are going to get Spain out of the problem which is about to arrive, nor, for that matter, will they prevent the inflation bonfire from currently roaring away in Eastern Europe which I was drawing attention to in my Slovakia post yesterday).