The Euro-Atlantic relationship - the economic challenges
Samuel Brittan: Venice 09/03/01

This part of the conference was originally meant to be about the relations between Europe and the US under a new Administration. Here I feel I have drawn the short straw. For there are no great economic issues between the two sides of the Atlantic other than the minutiae of trade disputes.

There will be no more cosy Third Way transatlantic seminars. But these have been a dying art form and in any case might not have survived the forthcoming Italian elections. Leave aside the mood music. How will relations change in practice?

In one way the Bush Administration may be easier to deal with. For it is less sensitive to trade union pressure about so called unfair competition from other countries eroding American jobs. These sensitivities have not however disappeared from Congress where Democrats and Republicans are more nearly balanced.

On the other hand, as in defence and foreign policy, the Bush administration is likely to be less patient with Europe dragging its feet. And to tell you the truth I do not blame it. The much heralded EU decision to end all barriers to import to imports from developing countries will not apply to sugar, rice and bananas for a good many years. Meanwhile the new US Trade Representative, Robert Zoellick, has warned that if the EU goes ahead with the banana regime planned for this year, it risks a spiral of transatlantic trade retaliation. A bigger source of conflict lies in the American conviction that the European Airbus represents subsidised competition for Boeing. One of Bill Clinton's last acts was to warn about the proposed Airbus financing. George Bush is hardly likely to be more emollient.

A new world trade round is still needed. Estimates of average tariffs give a misleadingly low impression of the extent of trade barriers still to be removed. The OECD gives a weighted average of customs duties of 3.7 per cent for the US, 6.6 per cent for the EU and 3.5 per cent for Japan. But these do not make allowance for non- tariff barriers and other complications. One French think tank estimates the true average level of protection in the EU at about 8½ per cent. (CEPII Newsletter, Winter, 2000-2001).

The Bush Administration is in principle amenable to a new trade round of tariff and quota cuts. But I do not think it is very optimistic; and it is obviously keen on a Free Trade Area of the Americas, both for its own sake and as a fall-back position. This is not the end of the world; but so long as producer interests are so heavily over-represented in the European Union process of decision, then we will have to accept the consequences.

I have been asked to say something about how the US slowdown or recession will affect Europe. The first question posed relates to capital movements and direct investment. Here the effects are quite likely to be favourable. Recently the USA has had a large trade deficit, which has been financed by a net inward flow of portfolio and direct investment from Europe and elsewhere.

If the US economy slows down relative to the European economy, then its attraction as an investment outlet should be reduced. Moreover, if American interest rates come down faster than European ones - which looks likely - the USA will be less attractive to short term capital flows as well. I am not predicting a complete reversal; but there should be more US investment in Europe and less European investment in the USA. There are dangers in an American recession, but from a different direction.

I am also asked about the perceived structural gap in innovation and economic performance. This is also not a subject over which I lose any sleep. US productivity has been higher than that of nearly all the rest of the world, including Europe, for at least a century. This has in a sense provided a relatively easy way for countries undertaking economic reform to put up a good performance. For all they really have to do is to catch up with US technology.

There has not been very much catching up in the last 20 or 30 years. This is largely due to the much discussed rigidities in the economies of many European countries - high labour costs, a reluctance to adjust wages to market forces, costly regulations which discourage employers either from innovating or taking on workers, and so on. The subject has been endlessly discussed and I will not elaborate.

In the last five years, however, not only has Europe failed to close the gap, but the US has moved further ahead. My guess is that this is one of the temporary developments which occur. Progress in the world's leading economy is not stable, but moves in fits and starts. There is no inherent reason why information technology should be concentrated in one country and I have little doubt that this widening of the gap is a temporary phenomenon which will provide more opportunities for catch-up.

How then is Europe likely to be affected by the US slowdown? If the American economy follows the gentle V-shape assumed by mainstream forecasters we do not need to worry much. Euro area exports account for only 2½ per cent of its GDP. A bigger impact can come from the growing European stake in American corporations. Sales of German subsidiaries in the USA are five times as high as direct German exports. Nevertheless we can be reasonably relaxed if American economic growth, which has been running at over 4 per cent pa. in recent years falls back to near zero in the first half of this year before recovering to say 2 or 3 per cent around the turn of 2001-2002.

But this is not the only thing that can happen. My fear is that there could be a two stage American recession, with some leveling off or modest recovery fairly soon, followed by a second stage dip. There has been a large personal sector deficit in the USA. The growth in consumption has therefore depended on consumer borrowing. This may have been justified when Wall Street was rising rapidly and taking real estate prices with it. But with asset prices, and therefore personal wealth, leveling off or even falling, consumers may well want to reduce their spending to what they can afford from current incomes.

The main way in which a severe recession is likely to affect Europe is via the stock markets. Capital gains are not nearly as important a source of personal wealth in Europe as they are in America. The channel of transmission is likely to be different. A Wall Street crash will almost certainly be followed by a European stock market crash. Either event, let alone both, will be enough to make European businessmen more pessimistic about their investment plans; and in this way the recession could spread.

But if there is one thing I do know it is that it is impossible to forecast the frequency, the dates or the severity of major recessions. Here I need to fall back on the cliches of central bankers. They need to be able to react quickly as soon as there is a clear and present danger. So do governments; but I am less sure here. Their record has been one of either too little too late or too much too late.

Finally, people may want me to say something about the dollar and the euro. In principle the Bush Administration is more opposed to any kind of currency accord than almost any previous administration in living memory. There is too much evidence of the evils which result from artificial attempts to impose desired ranges of currency fluctuation for it to be at all inclined to make another attempt. And I do not blame the new US Treasury Secretary, Paul O'Neill, for doubting the value of the innumerable international meetings at which Finance Ministers exchange well known and overoptimistic forecasts.

What could make the US shift its attitude away from benign neglect of the dollar? In a previous Republican Administration (the Reagan one) the change was brought about by a very high dollar going through the roof. This led to fierce protests from exporters, and Administration fears that Congress would go protectionist unless the dollar were reduced in value.

There is not much danger of such events happening in the foreseeable future. The US economy has lived for some years with quite a high dollar. The Fed is likely to cut interest rates faster than the European Central Bank; and this can only tend to bring the dollar down and improve the relative standing of the euro - not tomorrow or next week but over the course of months.

Looking back however several years further to the Carter Administration of 1977-80, there was indeed a period of panic about a falling dollar. The USA was then suffering from high inflation, and the fear was that an unlimited plunge in the dollar would make that inflation worse. In addition the Europeans were not happy to see the dollar become super-competitive. There was a time, a few of us may remember, when the then head of the US Fed, Paul Volcker, flew back early from an IMF meeting in Belgrade to inaugurate a much tougher domestic monetary policy. But in today's circumstances more harm than good would result if European countries were to start pressing for some formal system of target zones for exchange rates.

There is a much more interesting line of thought. There are too many currencies in the world. With nearly all the main economic powers pledged to rough price stability, there is nothing much to be gained from having the dollar, the euro, the yen and the pound as separate entities for major international transactions.

What I see happening eventually is the emergence of one great international trading currency which nobody will be forced to use. It can exist side-by-side with local currencies for domestic purposes, which will enable countries to pursue partially independent monetary policies if their own business cycle positions are different from the world average. But I have run out of time; and the organisers of this conference will have to decide whether further discussions of this prospect comes within the terms of reference.