Europe: Double Dip Recession or Japan Style Stagnation?

As a result of a recently leaked assessment from the UK Treasury the new British Government’s austerity budget will most likely lead to 1.3 million jobs being lost across the British economy over the next five years, with up to half of them disappearing from the public sector.

There are historical reasons for the particular weakness of Britain’s manufacturing and export base, and this time there is only a declining revenue base from North Sea Oil to ease the pain. The Anglo American, de-regulated, free market model was long on the primacy of the financial services industry and short on its regulation. It was also little interested in promoting manufacturing industry.

But right across Europe and the Euro-zone, the story is becoming depressingly familiar. Centre Right Governments such as that led by Chancellor Angela Merkel of Germany, are pushing ahead with major austerity packages. Centre Left Governments, such as that of Prime Minister Papandreou in Greece are being forced to follow suit – but for them, and for Southern European countries such as Portugal and Spain, the medicine risks so damaging the patient that the only real cure could yet be an exit from the Euro zone altogether, or nightmare of nightmares, a default on debts, many of these owed to German banks. While many Germans point to the profligacy of some of their southern neighbours, and a notoriously lax attitude to collecting taxation, others now accuse Germany of damaging the Euro zone house they built, and in the same way that they pulled the rug from under the Exchange Rate Mechanism. And had Germany not allowed irresponsible lending to Southern Europe, would those countries be in quite the mess they are today?

Chancellor Merkel now faces her own political problems with a fractious coalition, and a public alarmed at the sheer audacity of her deficit reduction programme. And reading between the lines of what President Obama had to say during the recent G20 Summit in Toronto, the US is pretty worried by Germany’s austerity programme as well, fearing that Europe’s biggest economy will shrink and demand for US exports shrink with it. Incidentally this is just what some of UK Prime Minister David Cameron’s critics are already saying about his budget of public spending cuts. Cameron and his Finance Minister, George Osborne presume that a private sector, export led recovery, will lead to economic growth over the longer term. But the question comes back to bite them; who exactly will be buying British exports? How is this recovery to come about when domestic and European demand will be so depressed?

Already some of the smarter economic commentators on both sies fo the Atlantic, have criticised the austerity programme of the British Government. “Too far, too fast!”, seems to be the verdict. Britain is not Greece, and in normal circumstances, a period of reasonable growht would beging to pay off the deficit. That is not going to happen, and each day Britons wake up to hear yet more dire news about public spending cuts impacting on frontline services.

The shocking truth is that European economic growth has been level pegging at around a measly 2% over the past fifteen years. This compares with Asian growth averaging 8% over the same period. Runaway economic growth in parts of China during the last decade – reaching an annual figure of 15% in one province of the industrial North east of the country I visited five years ago – so alarmed the Chinese Government, it felt obliged to intervene to dampen demand.

But there are more fundamental questions to be asked about this European growth figure, because some suspect that this relatively low average is based largely on European public spending, the ‘endogenous growth’ once trailed with such enthusiasm by Alan Greenspan of the US Federal Reserve and adopted with such relish by Gordon Brown, and which in reality was fuelled by nothing more substantial than the Dot.Com and property boom of the 1990s. Strip all of this out and it seems perfectly feasible that some European economies haven’t really grown in years, and that little wealth is being generated from those older reliables of the real economy. Put like this, Europe begins to look just a little sclerotic, some parts more than others. It seems truly astonishing that only a few years ago, there were European politicians who genuinely seemed to believe that they had banished the economic cycle, and that there was ‘an end to boom and bust’.

The United States may not have an awful lot to boast about either, although the Obama administration has resisted the deficit hawks, it is not meeting the twin concerns of American voters – job creation and the economy. But to all intents and purposes America seems to be a in a better place than Europe, even as the economic stimulus package begins to enter its wind down phase.

The real economic story of the next decade will continue to be the rise of China, the Middle East, India and Brazil, the latter with its burgeoning, consuming middle classes, whereas Europe, and in particular skewed economies such as those of Britain, risk slipping into a Japanese style period of deflation. Here is Richard Koo, economist at the Nomura Institute in Tokyo analysing Britain’s massively deflationary, cost cutting Budget; “The budget itself, I think, is rather poorly timed given our own experience in Japan. You never want to cut your budget deficit when the private sector is de-leveraging…. because we cut our budget prematurely in 1997, we entered into a very steep economic decline and it took us ten years to pull ourselves out of that”. That then is one scenario, but a more pessimistic view of the economic crystal ball has other economists and commentators fearing a second, double dip recession, brought on by the contraction of the major European economies.

For this the Europeans and the Americans have only themselves to blame. But at least America seems to have a better understanding of how to go for growth again.