Thursday, August 13, 2009

Why France & Germany Out Of Recession But Not UK?

The recent miracle showed by France and Germany’s economic recovery is highly likely to reignite the debate about just how robust and flexible the UK economy has turned out to be. Successive government was once so flamboyant and claimed that UK can perform much better without staying inside the Eurozone. This is because of so called flexibility where UK will not lose the power in controlling in monetary destiny. It can influence the level of interest rate which will successively determine private spending and investment. Also, it can manipulate sterling to change the fate of the beleaguered manufacturing industry

On top of that, the UK government is not constrained by Stability and Growth Pact, which states that in any fiscal year members of Eurozone should not incur a budget deficit of more than 3% and a national debt must not exceed 60%. As such, in theory UK suppose to be the first European nation to escape from recession since their ‘hands and legs are not tied’. However, the current situation is very disturbing. A-Levels Economics and related references probably will have to be rewritten and to some extent with lower tone, instead of bragging how great the flexibility was

Source: BBC

Why France and Germany escape recession before UK?

(1) Reliance on France and Germany. UK used to a consumption driven economy where private spending once stood at about 65%-70% of its GDP. Unfortunately, the present Great Recession has turned the British economy into a pessimism state. Certain sectors of the economy almost come to a standstill after consumption and investment spending have both collapsed. In such case, the health of the economy is then very much reliant on the other two components of AD which are public spending and exports. Bear in mind that about 55% of UK’s trade is with the rest of Europe especially France, German and Ireland. Therefore, it is not difficult to see that economies of France and Germany need to pick up before UK does

(2) Legacy of debts. It is also worthy to note that UK’s growth was paddled by credit boom in earlier years. Since interest rate was quite low and credit easily obtainable, British people had engaged in a form ‘luxury’ spending. The property market was the biggest beneficiary fuelling an increase in personal wealth at that time. The vicious cycle repeated itself through the process called mortgage equity withdrawal (MEW). Now, with the collapse of both economy and housing market many went into bankruptcies and some saddled by burden of debt in the midst of losing their job.

It is said that most of the income now goes to servicing the debts upon the loan they took out earlier. Meanwhile in France and Germany, their economy is not driven by property market and the percentage of house ownership is significantly lower. Therefore debt is ‘trivial’ and with great level of household savings in Germany, the people can spend themselves out of recession

(3) Less exposure to financial crisis. Although Germany and France experienced similar problems in their financial sector, it was not to the similar extent as in UK. The Labour government is reported to have spent nearly £1.5 trillion in bailing out the financial sector, an amount which is significant as a percentage of GDP and much bigger than total spending by the rest of G20 put altogether. Clearly, UK’s financial sector still has a long and winding road ahead. Banks are still relying on state financing and until now very much reluctant to lend as can be seen from the high deposits required for any form of lending. One need to understand that banks are the main facilitator of economic activities, which without will be major impediment on road towards recovery

(4) Stimulus plan for auto industry. The German’s car-scrappage scheme has been accredited for turning around the fortunes of its automotive industry. At €5 billion, it was on an entirely different scale to the UK’s £300 million scheme. This scheme has been so successful that it has been extended until the end of year after attracting 1.2 million applicants. The initiative actually offers buyers new and more fuel-efficient car in return for their nine years old car

In fact purchasers benefited twice. First, falling demand leads to lower car price and with further € 2500 subsidy, car price looks even much cheaper. It has great domino effect. A revival of auto industry will have multiplier effect onto other car related industries. More jobs will be created. As people begin to spend, they will eventually jump start every sector of the economy. It is unlikely that British half-baked policy could produce such desirable result

(5) Growing demand from outside. Unlike UK, Germany’s economy is export-driven. As such, with the collapse of global commerce, its economy sank by as much as 6.7%, a bigger figure if compared to contraction in UK by 4.9% in the first three months of 2009. However the revivals of Chinese economy and reported stabilization in US have both fuelled demand for Germany’s exports particularly high end manufactured goods, thus pulling it out of recession earlier than expected. The latest statistic shown that German exports had grown at their fastest pace for nearly three years at 7%. This has positive spillover effect onto France economy as German is its major trading partner. UK’s fate is somewhat different since it has grown to become a service based economy

(6) Relaxation of fiscal rule. The Growth and Stability Pact is believed to have permitted certain flexibility onto France and Germany, therefore allowing them to spend more than usual. No doubt, both run huge budget deficit and have enormous national debt, but if we were to stringently follow the book, situations could have turned for the worse. Pro-long recession will inevitably lead to higher unemployment, deflation and increasing difficulty to finance debts. Besides, these two are the largest economies in Eurozone. Their survival will lead to the survival of the rests of Europe. The recent reported contraction in Eurozone was 0.1% and this figure would have been much larger if not due to the green shoots recovery of 0.3% in France and Germany

In the next posting, I will discuss the potential downside risks towards recovery

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