European leaders have been slow to admit the global economic slowdown has reached their shores. But evidence is becoming overwhelming, particularly in Germany, Europe's main economic engine. Likewise, Europe's linkages to U.S. and global economic forces are more profound than many in Europe profess. Signs are pointing to a dramatic economic slowdown in Europe this year.
After a bilateral summit with his German counterpart, Hans Eichel, French Finance Minister Laurent Fabius like other European leaders - seems guardedly optimistic in his outlook for the European economy.
”Happily, Europe is slowing down much less noticeably than elsewhere,'' Fabius told reporters at a Roen, France, press briefing, revealing two important aspects of the prevailing attitude in Europe toward the economy there.
European leaders will acknowledge Europe is indeed slowing, but most believe the slowdown will be comparatively minor and that aggressive action won't be needed. Though the first point is indisputable, the second is far from it. Europe looks poised for a more drastic downturn than Brussels, Paris or even Berlin seem prepared to admit.
European leaders' cups are half full rather than half empty. They point to certain economic indicators to support the view that ”things really aren't that bad.'' But closer examination yields a more troubling picture.
Dark Clouds From the East
European growth starts and stops with Germany, which accounts for 35 percent of gross domestic product in the eurozone - the 12 countries that make up the European Monetary Union (EMU). It is also Europe's largest single market for goods and services.
Germany is also leading the pack as regards a slowdown. The country's revered Ifo business climate index plunged from 97.5 for January to 94.9 for February, far below expectations. The important business expectations component of the index showed its steepest one-month drop in a year. The Ifo index is a key indicator of companies' investment plans, with drops pointing to declining business investment.
German unemployment also rose for the third straight month in March after two years of declines. The rate now stands at 9.3 percent. Meanwhile, Germany's high-tech stock market, the Neuer Markt, has fallen 76 percent from its 52-week high last May.
Investment banks have responded in the last several weeks by revising 2001 German growth forecasts downward from previous forecasts of around 2.6 percent. UBS Warburg now expects 2.2 percent growth, and Morgan Stanley is more pessimistic, calling for 1.8 percent growth in real GDP this year. Yet Chancellor Gerhard Schroeder stated at the end of March he sees no reason to revise his government's official forecast of 2.75 percent growth this year.
Dark Clouds From the West
After Germany, the most important nation for Europe economically is the United States. European capitals like to proclaim Europe's self-sufficiency, pointing out that only 2 percent to 3 percent of eurozone GDP comes through trade with the United States. But European reliance on the United States and the global economy is much greater than trade figures make it appear.
Economic forces are transmitted to Europe from the United States and other global markets not only through external trade but also through returns on foreign direct investment (FDI), the capital markets and consumer sentiment.
According to Morgan Stanley, sales of European affiliates based in the United States were $1.1 trillion in 1998, four times the amount of American imports from Europe. While the United States buys only 10 percent of German exports, the country's U.S.-based operations bring in about $250 billion in annual sales. And while the United States buys 13 percent of eurozone exports, Europe's top 300 companies derived around 21 percent of their sales from the Americas in 1999, according to HSBC Securities. An economic slowdown in the United States certainly affects the balance sheets of a large percentage of European companies.
European companies also invested heavily in the United States in the last several years, through the stock market, FDI and the direct acquisition of companies. Just as they hoped to take advantage of the American boom, they will also suffer during the American bust.
According to U.S. Commerce Department data, income of U.S.-based European affiliates dropped to its lowest point in two years in fourth-quarter 2000, down 26 percent from the third quarter and 38 percent from second-quarter 2000.
Europe will suffer in the same way from slowdowns in other markets, including Central Europe, Asia and Latin America.
As the world's largest exporter, a slowdown in global trade is also bad news for Europe. Six of the world's top 10 exporters are from the European Union. Extra-EU exports of $795 billion accounted for 18.8 percent of world merchandise trade in 1999, exceeding both the United States (16.4 percent) and Japan (9.9 percent), according to the World Trade Organization. Intra-EU trade was valued at $1,385 billion. Morgan Stanley predicts the growth in global trade volumes will decline from 12.4 percent in 2000 to 5.9 percent in 2001, the largest one-year decline on record.
It's the Old Economy, Stupid
And yet, European consumer confidence appears to be holding up. EU indicators remained steady in March compared with February. But this again tells just a small part of the story. The first to be hit by a global slowdown are not European consumers, but rather European businesses, in particular, industry.
Here the numbers are bleaker. Business confidence among European companies fell in March - marking six straight months without an uptick - to the lowest point since November 1999. Business confidence has fallen for five straight months in France and in Italy to its lowest level in 18 months. A 12 percent drop in the first quarter 2001 in the Dow Jones Euro Stoxx 50 Index, a benchmark of eurozone stocks, reflects declining confidence that European companies will meet profit targets.
More disturbingly, industrial production in the eurozone fell 1.9 percent in January from December. According to Morgan Stanley, extra-EMU exports dropped 12 percent in the three-month quarter ending January. And the Wall Street Journal reports growth in the eurozone services economy fell to a 26-month low in March.
The slowdown has clearly hit European industry. Inventory overhangs resulting from slack consumer demand in Europe in the latter half of last year are becoming more substantial as overseas sales drop. As businesses begin to feel the effects of a slowdown in global demand through trade and declining profits from foreign-based operations, they will cut investment plans, downgrade profit expectations and announce restructuring and downsizing plans.
This is just starting to occur in Europe. Bad news abounds from high-tech stars like British Telecom and Ericsson, but those signs are often written off as part of a global slump in technology. The more traditional manufacturing and retail sectors - the old economy - really tell the European story.
The slowdown in industrial production and flagging business confidence is manifesting itself in layoffs and closures. French food group Danon announced the closing of six of its 36 European plants. UK-based store chain Marks and Spencer will close 38 department stores across Europe, including 18 French outlets employing 1,700 people. MAN AG, a German truck maker, expects the European truck market to shrink by 8 percent this year and announced last week it will fire 1,200 workers.
As these and other announcements sink in, and as job cuts take hold, European consumer confidence and demand is sure to fall. This will lead to a second, homegrown phase of the downturn. Here, Europe's professed self-sufficiency will work against it, as global demand - which by then should be increasing slightly - will be unable to offset weakening domestic demand.
Without a motivating factor, like cheap and available credit, European companies are likely to retrench over the next six months in order to wait out the global economic storm. Begging the question, what, if anything, can Brussels do to invigorate the economy?