To get out of its economic crisis Europe needs to learn from China

To get out of its economic crisis Europe needs to learn from ChinaBy John Ross

Four years into the international financial crisis, it is clear that the economic policies followed in Europe to deal with it have failed to do so. For a long time, there was a refusal to examine the real facts of Europe’s economic situation and take the appropriate policy measures. Once Europe does start to analyse its economic problems correctly, however, it will see that it has a lot to learn from China. Naturally this does not mean that Europe can mechanically copy China’s approach, but there are important trends which Europe can study.

The fundamental trends in Europe’s economy are illustrated in Figure 1. This shows the changes in different components of the European Union (EU)’s GDP since the first quarter of 2008 – the peak of the last business cycle and immediately before the onset of the financial crisis. It may be seen that the negative trend in the EU economy is entirely dominated by its fall in investment. The EU’s trade balance has improved during the financial crisis, government consumption has risen, and the fall in personal consumption is relatively small. But the fall in fixed investment is huge, amounting to 150 percent of the total decline in GDP. This fall far more than offsets the performance in other economic sectors. The economic situation in Europe is therefore entirely dominated by this investment fall.

Figure 1

12 05 13 EU

After four years of failing to look at the real situation, an identification of this actual core problem in Europe’s economy is beginning to emerge. European Parliament President Martin Shulz recently wrote on Europe’s crisis: “…what is to be done? First, targeted investment should be given priority.” José Manuel Barroso, the European Commission president, and Olli Rehn, the European commissioner charged with dealing with the euro crisis, have now said it is likely that EU leaders will agree next month to increase the capital of the European Investment Bank by €10bn ($13 billion), which could be used as collateral to start large infrastructure “pilot projects” on a pan-European scale.

These policy changes, while a step in the right direction, are too small to turn the situation around. The EU is a US$16 trillion economy. The idea that a $13 billion program, only 0.06 per cent of the EU GDP, can offset the US$343 billion decline in EU investment since the first quarter of 2008 is clearly unrealistic.

The European Commission admits that there is €82 billion (US$106 billion) in unused structural funds in the EU’s medium-term budget. This could theoretically be used to tackle the investment decline. But firstly, even the use of this entire sum is less than one third of the decline in investment which has taken place in Europe. Secondly, national governments have not yet agreed that these funds can be used for a European investment program.

Therefore four years after the beginning of the crisis, EU governments are beginning to discuss the right issues, but the practical measures they are proposing are still much too small to deal with the scale of problems that Europe faces.

The difference with China can be seen clearly in Figure 2, which shows the results of the stimulus program launched by China in 2008 to counter the international financial crisis. This stimulus program directly targeted raising investment – in particular infrastructure and now housing. The results are evident. Far from falling sharply, as in Europe and the US, China’s investment rose.

Consequently, compared to the situation on the eve of the financial crisis, China’s economy expanded by over 40 per cent in four years compared to growth of 1 per cent in the US and a contraction of 2 per cent in Europe. China’s stimulus program was $586 billion, or about 13 per cent of China’s 2008 GDP – the majority part directly targeted investment.

Figure 2

12 05 13 Change in components of GDP

China’s stimulus, in terms of proportion of GDP, is equivalent to a program of US$2 trillion in the EU today. An investment program on that scale would be substantially too large in the EU at present – the situation is not as critical as in 2008. Nevertheless it is only necessary to compare this number to the $13 billion discussed by EU commissioners today, to see how inadequate is the scale of the proposed EU response to the present situation.

Jens Weidman, president of Germany’s Bundesbank, has complained about the lack of policy tools available in Europe: “Now that fiscal stimulus has reached the bounds of feasibility in many countries, monetary policy is often seen as the ‘last man standing’…However…contrary to widespread belief, monetary policy is not a panacea and central banks’ firepower is not unlimited.” But Weidman’s conclusion exists only because Europe, somewhat arrogantly, refuses to study the country which passed most successfully through the international financial crisis – China.

Two years ago I wrote: “The dispute… between the US and Europe over’economic stimulus’ versus ‘deficit reduction’ convincingly demonstrates the superiority of China’s system of macro-economic regulation. China has faced no similar dilemma. It has simultaneously carried out the world’s biggest economic stimulus package while running a budget deficit which is entirely sustainable – under 3 percent of GDP. China has therefore not had to face the choice between continuing fiscal economic stimulus measures and placing the priority on budget consolidation.”

This remains the key problem. Unless Europe is prepared to grasp the nettle of a large “China style” program, one based on state-led investment, Europe is likely to face, at best, years of economic stagnation.

China’s authorities have always rightly clarified that it is not arguing for its economy to be a model for others. It rightly insists every country is specific and therefore no country can or should mechanically copy another. But nevertheless China learned many things from other countries. For its own sake, Europe should start to learn from China

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This article originally appeared at Key Trends in Globalisation.T Walker