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The UK and the eurozone in the shifting global economy

Guest blogger, LSE professor Danny Quah, looks at the economic difficulties facing the UK and the eurozone and what can be done about them

The economic difficulties in the UK or the eurozone cannot be usefully analysed without looking at these economies’ positions in the world. The UK and the eurozone also have an immediate problem with debt and an ongoing problem with productivity. It is unlikely that Keynesian aggregate demand management alone will lead to long-run sustained growth.

What are the facts on the UK and the eurozone in the global economy? Time was, the night-time sky was lit up pretty much just by the Transatlantic axis.

But that was 30 years ago, and the global economy has moved on. By 2010 the world’s economic centre had shifted 5,000 km – three-quarters of the Earth’s radius – from the rise of the east, notably India and China.

As a consequence, hundreds of millions of Asians have been lifted out of grinding poverty; soon these people will be the world’s middle income class.

That figure of the great shift east takes in grubby calculations with thousands of data points. But its point can be appreciated in many different ways, some more vivid than others (eg the view from the US).

To be clear, not all Europe needs help in the same way. By the summer of 2011, a distinguished US economist had related to me how he and colleagues were surprised by German economic growth out of the 2008 global financial crisis since, while keeping its traditional high-savings habits, Germany had its export markets — the US, the rest of the EU — mired in ongoing recession. Here, however, might be part of how Germany did it:

The great bulk of German trade remains, naturally, with the rest of the European Union. But the EU is now deep in recession and likely to remain so for some time. Outside the EU? Germany today exports more to Developing Asia than it does to the US. And that gap continues to rise. Exports to China alone already appear as large as those to the US. Part of this obviously stems from US imports sharply falling right after 2008 – but that is exactly my point. China and Developing Asia continued to grow, continued to import from Germany (and elsewhere), and thus continued to keep parts of the global economy afloat throughout both the global financial and European sovereign debt crises.

This is not just because Germany enjoyed a cheap currency. Despite the weakness of pound sterling against the Euro, the UK has not re-oriented its exports anywhere as successfully as has Germany:

What the UK exports to the US remain double UK exports to Developing Asia, and four times UK exports to China. The UK has simply ended up with most of its exports to economies showing no significant demand growth.

Unpack the numbers further by breaking out the UK’s 50 largest trading partners in 2009: the UK had 56% of its exports go to the 10 slowest-growing economies in that group (growth measured 2000-2008). Across these 50, the correlation between exports and growth was -0.32: the UK systematically exported more to those trading partners growing slower.

The problems faced by the UK, or more broadly, by member states across the entire EU, while different in concentration, are no different in character from those in the 2008 global financial crisis: Large entities owe large amounts of debt and are likely unable to pay it all back. Previously, the entities were financial institutions; now they are sovereign states. Quick fixes that seek to get around repaying this debt will undermine institutions of trust and responsibility, those same institutions the west tells emerging economies they must build if they too want to become developed economies.

When the first round of Quantitative Easing (QE1) happened in the US, output there rose – and to a smaller extent elsewhere in the world as well. With QE2, IMF estimates show the impact multipliers everywhere had diminished sharply.

Now? There are those who hope a rescue will come when the ECB unleashes its own QE on Eurozone sovereign debt. Or some optimistically-ingenious scheme involving different-coloured centrally issued Eurobonds, or where the discrimination occurs across member states using some other indicator might work. With luck perhaps. Longer term, some observers look to a fuller-fledged fiscal union, with Germany transferring likely more than 5% of its GDP to the eurozone’s lesser-performing periphery member states.

But the connection between this re-organisation and member states’ fiscal positions cannot be ignored. While all attention now focuses on deficit/debt figures compared to those originally given in the Maastricht Treaty, pretty much totally neglected is the nearly-contemporaneous Copenhagen criteria for EU accession. That list includes – after requiring member states be democracies that obey the rule of law, respect human rights, and protect minorities – the statement that candidate member states need to be market economies able to deal with “competitive pressure and market forces within the Union”.

I’m sorry but I don’t think receiving a perpetual 5% German GDP transfer strong evidence for that capability. (And this is just for EU accession, not even for eurozone membership.)

Monetary or other financial rescues are short-term; we need them the same way we need to kickstart an engine. But if that engine is worn out or is leaking fuel or in need of a complete overhaul, I don’t see how we are going to get very far with that machine. We can’t mistake a short-term boom fuelled by exigent government actions for sustained long-term growth. Again, isn’t this what the West tells emerging economies?

How would I propose to change matters? My suggestions at the event were general and therefore impractical. But here they are again:

• Reboot the UK economy: Take the pain and turn around to engage fully with the emerging economies; do business with them as economic partner — no more, no less. The emerging economies are now the world’s engine of growth: Deal with it.

• Unleash our universities and other thoughtful, creative industries. This is NOT to raise government spending, but just to free up extant restrictions on their operations. UK higher education is hugely in demand by the emerging economies. If there’s anything that’s going to help re-balance the global economy, this is it.

• Throw out long-standing aesthetics and principles – they’re also called prejudices. Become enamoured of what works — whether it’s guided capitalism under a bit of state control or anything else we previously thought completely nuts (ie outside the Washington consensus). Celebrate the virtues of working hard, raising productivity, saving for the future – not revile them as many do today for Germany or used to do most obviously recently only for China (and yet might come back to doing so again soon). © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved. | Use of this content is subject to our Terms & Conditions | More Feeds