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US poised to grow as Europe slides

By Neville Bennett

Friday 23rd May 2003

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Two significant events in the US economy this week saw the yield on the 10-year bonds plunge to a 45-year low and the dollar establish a four-year low against the euro; it has now depreciated about 40% since 2000.

At first sight, these are ominous developments. Yet, while there are implications of vulnerability, the outlook for the US economy has improved and Europe is under renewed pressure.

The fall in US bond yields is an expression of declining interest rates, which is extremely positive for American businesses. It is too little understood that these have addressed their problems in a flexible and dynamic manner. They are now poised to take advantage of the opportunities arising from a de facto devaluation.

The adaptability of American business seems greater than that of its European counterparts, which are also disadvantaged by regulatory fetters. Arguably, American business is also more anxious to please its shareholders, for any lapses in performance are brutally punished by the market.

Europe will receive a flood of US exports, swept along by the competitive advantage of 40% devaluation.

American business has rapidly transformed itself after an intense period of change and adaptation from the collapsed stockmarket bubble and corporate scandals. It has refocused on its roles, cut costs and downsized. It has learned to deal with competitors in its home market. It is more competitive than ever.

Europe is less match-fit. Its labour market is rigid. Business is beset by pettifogging regulation emanating from Brussels. Government monetary and fiscal capabilities are circumscribed by initiative-deadening rules.

How will Europe respond to the American onslaught? It will be conscious of the challenge; unions will fight to retain their privileges, while managers will try to cut costs. There will be vociferous demands for lower interest rates.

But structural reform is unlikely. A more probable scenario is that business and labour will call for more protection and subsidies.

These will be deemed necessary to protect jobs and avoid industrial relocations. They will be perceived as reasonable in the short-term.

This creates adverse circumstances for the success of the WTO's Doha round. Recent G8 meetings have been replete with pledges of further liberalisation, and even more compassion. It is unlikely more access will be granted to rich countries' home markets. But, the agenda will lavish attention on improving rules relating to public procurement and trading facilities. More discourse on competition and investment issues is bound to follow.

This agenda will naturally exclude New Zealand from any practical benefits. It seems to fall between two stools, those of the developed and developing world. Deadlines have already been missed on agriculture.

However, scope remains for endless talks on improving the poor's access in education, healthcare and "social safety nets." It is easy to pledge "increased resources" to fight poverty but almost impossible to relax restrictions on agricultural imports.

Meanwhile, Europe's concern about deflation is palpable. French Finance Minister Francis Mer says, "Inflation is now very much behind us." He might have added that significant economic growth is almost gone too.

French growth is 1.1%. Germany is in recession. The UK is slowing rapidly. House prices are falling and retail sales have the slowest rate of increase in four years. Europe looks as if it might share Japan's fate and its leaders keep suggesting that the US reflate in order to drive the world economy.

Germany's difficulties seem almost beyond redemption. Unemployment has reached 11%. Industrial production is falling and orders are melting away as prices rise and demand slackens. The financial sector is also in difficulty.

Its ability to recover is severely circumscribed by EU rules. Monetary policy cannot be used to promote growth or combat inflation as interest rates are set by the central bank.

Nor can it use fiscal policy effectively. It cannot adopt the classic Keynesian method of combating deflation: issuing a budget that spends more than it receives in revenue. The rules are that it has to deliver balanced budgets.

Deflation is a probable scenario. If that comes to pass, Germany will have many other problems. The government will have to live with even less revenue. The unemployed will grow and so will the benefit bill. The pension bill will seem disproportionate, as pension values will increase in real terms.

In short, if deflation becomes entrenched, there will be new debates on the nature of efficiency and equity. Consumers will postpone purchases, as prices will get cheaper. Demand will keep falling, and the government will be almost powerless to prevent the slide.

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