European Economy Follows U.S. Into Downturn

0 Comments | Insight on the News, July 30, 2001 | by Jamie Dettmer

The swagger is disappearing quickly. For most of the year the Europeans felt superior -- their collective economy was doing better than America's, and they pooh-poohed warnings from U.S. Treasury Secretary Paul O'Neill and the International Monetary Fund that Europe shouldn't count on being immune from the downturn in the United States.

When U.S. Treasury officials added their voices in the spring to those of Wall Street urging the European Central Bank (ECB) to follow the Federal Reserve and be aggressive in reducing interest rates, the Europeans tittered. The French actually pontificated that their economy this year would outperform that of the U.S.

Likewise, on the political front the Europeans believed they had the advantage. The chaos of the presidential election last year prompted broad grins this side of the Atlantic and a shaking of heads. The widespread sentiment was that the European Union (EU) was better organized and more democratic.

But with the shine now off the Euro-zone economies and political challenges emerging quickly to the expansion of the EU eastward, including a "no" vote in the Irish referendum, there is noticeable anxiety here and a touch more restraint in knee-jerk ridicule of all things American. Belatedly there is realization that Europe isn't immune from the economic problems roiling the United States and that trouble on one side of the Atlantic spells trouble on the other.

The latest European economic data make for grim reading. The June Purchasing Managers' Index (PMI) for Euro-zone countries has slipped to its lowest level since December 1998, suggesting the region's manufacturing sector is heading for an unpleasant slump.

Not that all Euro-zone countries are performing that badly -- here in Italy the index declined just a little, and in Britain and France the PMI rose slightly. But leading the way lower is Germany, the engine of European industry. "The German figures are very disquieting, with precious little sign of any turnaround," said Klaus Baader, senior international economist at Lehman Brothers. The United Kingdom's manufacturing sector has contracted for four straight months and hit a 28-month low in May. Output and employment continued to contract in June.

The stock-market scene is no better. Barring a highly unlikely dramatic turnaround, this year could mark the first contraction in European equity issuance since the market explosion of the mid-1990s. The second quarter of the year traditionally is the busiest for companies selling shares, but equity issuance in Europe is down 48 percent and initial public offerings (IPOs) of stock are off 60 percent. For the third quarter and beyond, only a handful of IPOs are scheduled. "There's very little we can see for the rest of the year," said John Crompton of Morgan Stanley.

With Europe now entering the eye of the economic storm, the ECB is coming across less as a model of competence and efficiency and more as an overly cautious body obsessed with inflation and its own prerogatives. Already under attack for its mishandling of interest rates and allowing the euro to plummet against the dollar, the central bank is at odds with European governments over whether current board members should be allowed to succeed Wim Duisenberg as the ECB president when he retires later this year.

It all comes down to different interpretations of the Maastricht Treaty. With French, German and Italian contenders all jockeying for position, the dispute is fast becoming a serious embarrassment, adding to the woes of a bank that is only 3 years old.

Of greater concern in the long term are signs of mounting public reluctance within the EU to the plan to admit as many as 12 more countries. The Irish vote against expansion has shaken confidence in the enlargement process. In a bid to reassure the eager applicants, EU leaders at their summit in Gothenburg, Sweden, made a declaration setting a date in 2002 for the conclusion of membership negotiations for the most advanced applicant countries and announced that enlargement is "irreversible."

But few believe it, especially as there are plenty of escape clauses and words such as "commitment" are few and far between. Membership treaties would have to be ratified by every national parliament in the EU, and the Irish aren't the only ones who are unhappy. The Greeks, Italians, Spaniards and Portuguese all fear that the EU subsidies they have enjoyed for years would be diverted to the poorer new members. And the Germans are not alone in disliking the idea of free movement of labor being granted to more Poles, Czechs and Turks.

Membership expectations have risen dramatically in Eastern Europe, and a failure in the enlargement process could have a major impact in relations across the continent and for centrist governments in the former communist states.

Trying to deepen the union while at the same time expanding it always was going to be a Herculean task. But the euro-enthusiasm of Brussels seemed unstoppable -- until now, that is. As one Italian diplomat here remarked: "Europe has been too keen on running when it still needs to learn how to walk."