America Pulling Ahead of Europe

New Eurostat numbers confirm a growing macroeconomic divide between Europe and America. In only a few years, the same $100 could be worth a lot more in the United States than in Europe. For this to happen, a fair amount of things have to go “right” Stateside, but not much needs to go “wrong” in Europe. In fact, the IMF is now expressing strong concern about the course of the European economy. From the EU Observer:

International Monetary Fund (IMF) chief Christine Lagarde has said that eurozone leaders should “keep the momentum” of reforms like the banking union, as recession is now forecast to linger on in 2013. “2013 will be a make or break year. The biggest risks are in the developed countries – Japan, the eurozone and the US, there are threats if they don’t keep up the momentum,” Lagarde said on Wednesday (23 January) during her speech at the World Economic Forum in the Swiss resort of Davos.

She is right about the eurozone, for sure, probably also about Japan. The United States is a wild card: if the Obama administration gets the fiscal policy it wants we are going to dive straight down into the zero-growth zone where Europe has been dwelling for a few years now. Taxes will go up, massively, and there will be more government spending programs that get in the way of productive, private enterprise. If on the other hand Obama takes a more passive route and concentrates on being a ceremonial king instead of a policy maker, there is some real chance for good fiscal policy coming out of Washington, DC.

With more and more states putting up a fight against Obama on fiscal issues, and with a re-energized Republican party coming out of policy conventions the past two weeks, the latter scenario is a bit more likely than the former. If the American economy benefits from a president who is more interested in playing golf than raising taxes and a Congress where the Democrats are finally scared fiscally straight by a re-energized GOP, then the U.S. economy will be chugging along at fairly decent growth rates in the next few years.

This is reflected in Eurostat’s latest national accounts numbers for GDP growth. They forecast that the EU as a whole will see inflation-adjusted growth (year 2000 index) at -0.3 percent for 2012, a microscopically positive 0.4 percent in 2013 and a tiny 1.6 percent in 2014. By contrast, Eurostat’s forecast for the U.S. economy is, respectively,  2.1, 2.3 and 2.6 percent.

In plain terms, this means that if you made $100 in the United States in 2011, you’d make $107.12 in 2014, while in Europe the same $100 income would only rise to $101.75.

The gap is likely to grow even bigger, as the Europeans have not yet given up on austerity. Having said that, the “flip side” scenario would be one where:

  • Europe acknowledges past mistakes, stops raising taxes and executing irresponsible spending cuts and instead allowed the private sector to pull the economy out of its seemingly perennial recession; and
  • The Obama administration together with Congressional Democrats and Republicans were struck by fiscal panic and started repeating the European austerity mistakes – or even took Obama’s favorite route of raising taxes and spending.

If this happened the above-reported numbers might very well be flipped. However, this is a very unlikely scenario, primarily for political reasons. The Republicans would never accept Euro-style austerity in America, despite whatever wet dreams of such policies are harbored by some libertarians on the Tenderfoot Coast between Times Square and Tyson’s Corner.

But wait, there is more to this. While it is relatively easy to give macroeconomic validation to the forecast that Eurostat has for the American economy, it is much more difficult to justify a turnaround in the European case. The IMF hints at this, as reported by the EU Observer:

Earlier that day, the IMF revised its global growth forecast, giving a more pessimistic outlook than three months ago: instead of a 0.1 percent increase in the eurozone this year, the Washington-based lending body now predicts a recession of 0.2 percent.

This follows on the heels of previous downward adjustments that among others the IMF has been doing, following in their view surprisingly negative growth effects of austerity. The IMF, which courageously and respectably acknowledged its prior mistakes, is now trying to catch up with its own new insights as it maps out the fiscal future for Europe. It is likely that we are going to see further downward revisions of the numbers for the EU.

That does not mean the IMF has come to full grips with its own policy recommendations. As the EU Observer reports, the IMF boss still believes in so called fiscal consolidation, which is fancy dinner talk for more austerity:

“Fiscal consolidation, however painful it may be in some areas of the eurozone, must continue, as well as a clear focus on jobs,” Lagarde said. She repeated what top economists at the IMF admitted in a study earlier this month – that “policy makers did not pay enough attention to inequality” and focused too much on spending cuts at the expense of the most vulnerable in the society.

In other words, the multiplier is stronger among low-income consumers than among high-income consumers. The problem for Europe’s welfare states is that the low-income consumers are their biggest customers. Therefore, when you cut spending along the slash-and-burn principles of austerity – as opposed to sound, long-term structural cuts – you will have the destructive effects that the IMF has of late become aware of.

As a matter of fact, the very difference between destructive austerity cuts and sound structural spending cuts could become the guideline that distinguishes America from Europe in the next 5-10 years. There is a growing awareness, and a growing political willingness, among moderate, conservative and libertarian Americans – who together make up roughly half the voting population – that government can no longer keep growing, but must shrink permanently. The GOP has a cadre of strong governors, controlling 30 of the 50 gubernatorial seats, with a new generation of fiscally conservative friends of limited government building their executive resumes.

Europe, on the other hand, has lost its overall course, intellectually as well as economically. I am increasingly convinced that Europe is actually entering a permanent state of industrial poverty, where children grow up with the prospect of, at best, having as prosperous a life as their parents. More likely, though, will be that they will have to sacrifice some of the living standards that their parents enjoyed – without getting anything in return from government.

There is much at stake in the coming years, on both sides of the Atlantic. If I had to bet a large amount of money on which side will come out strong, prosperous and free, it would be the United States (and Canada, let’s not forget them). But that does not mean the fight to secure our children’s future is over.

It has barely even begun.