Europe – the lost continent?

Howard Davies

Director, LSE

ICEF

HSE Cultural Centre

29 November 2010

The continuing Eurozone crisis is a cloud hanging over Europe:

- How far is the economic gloom justified?

- Has Europe faded into economic and political insignificance?

- If so, should Russia care?

After the recession, global growth is resuming

Global GDP growth, annual % change, 2003 - 2015

Source: IMF WEO Database, October 2010.

-4

-2

0

2

4

6

8

10

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

World Advanced economies Emerging and developing economies

Note: Estimates start after 2009.

China is once again the star performer

UK, US and BRICs’ GDP growth, annual % change, 2003 - 2015

Source: IMF WEO Database, October 2010.Note: Estimates start after 2009.

-10

-5

0

5

10

15

20

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Brazil China India Russia United Kingdom United States

Source: JPMorgan.

Emerging market consumption now surpasses US levels

US and EM consumption as % of global consumer spending, 1990 - 2008

The World’s Economic Centre of Gravity is moving eastwards

Source: Grether JM, Mathys N (2008): Is the World’s Economic Center of Gravity Already in Asia?

Projection of the World’s Economic and Geographic Centre of Gravity

Source: FT Interactive: Europe’s economic weather map.

The European prospect has also improved, but not everywhere

So in Europe

• overall growth is sluggish and• the eurozone is under great pressure.

The European Union: 500 million people – 27 countries

Source: Eurostat.

EU population, million people, 1986 – 2010

The Euro: A single currency for Europeans

Source: http://europa.eu/

EU countries using the euroEU countries not using the euro

The EU economy is close in size to that of the US

Source: IMF World Economic Outlook, October 2010.

GDP, current prices (Billion US dollars), 2009

EU (16,415 Billion USD) US (14,119 Billion USD)

How rich is the EU compared to the US, Russia, China, and India?

Source: IMF World Economic Outlook, October 2010.

0

5,000

10,000

15,000

20,000

25,00030,000

35,000

40,000

45,000

50,000

US

EU

Russia

China

India

GDP per capita, current prices (US dollars), 2009

The EU-15 still has a substantial per capita GDP gap with the United States

Source: MGI. Beyond austerity: A path to economic growth and renewal in Europe. October 2010.

GDP per capita, $ PPP thousand, 2009

Europe has already created many new jobs above population growth in the past decade

Source: MGI. Beyond austerity: A path to economic growth and renewal in Europe. October 2010.

Additional jobs, million, 1995 – 2008

Note: Numbers may not sum due to rounding.

And largely defended export market shares despite the rise of the BRICs

Source: MGI. Beyond austerity: A path to economic growth and renewal in Europe. October 2010.

Market share of total world exports¹, %, 1999 and 2008

1 Excluding intra-EU-27 trade.2 Brazil, Russia, India and China.

But there is nonetheless a serious problem

The euro was expected to bring convergence in economic performance, but

- productivity growth by region has been very different, and

- the competitiveness of periphery countries has lagged.

- fiscal deficits have ballooned in those countries, and

- the markets have become concerned at the prospect of default.

Southern Europe continues to lag behind in productivity growth

Source: MGI. Beyond austerity: A path to economic growth and renewal in Europe. October 2010.

Productivity, $ PPP per hour worked, 2009

Note: Nothern Europe: Denmark, Finland, Ireland, Sweden, UK. Continental Europe: Austria, Belgium, France, Germany, Luxembourg, Netherlands. Southern Europe: Greece, Italy, Portugal, Spain.

Real exchange rate* and relative export performance, cumulative change between 1999 and 2008

Source: Bruegel Policy Brief, March 2010.

There has been a remarkable divergence in competitiveness

*Real exchange rates are based on unit labour costs.

10-year bond yields, %, 1 Jan 2010 – 12 Nov 2010

Costs of borrowing in the Eurozone have been growing apart

Source: JF Kirkegaard: Turmoil in European Bond Markets, but the Sky Is Not Falling. Peterson Institute for International Economics. 15 November 2010.

The EU response has been hesitant:

- An ad hoc rescue package for Greece, with the IMF,

- A ‘temporary financial stability facility’ which was not intended for use,

- Another ad hoc package for Ireland,- Leaving question-marks over Portugal, Spain

and even Italy.

It is now clear that to survive in the longer term, the Eurozone needs:

- A fiscal pact that works,- A permanent ‘European Monetary Fund’,- A financial sector bail-out mechanism.

But these plans require treaty change, which is politically complex.

Three possibilities

• Muddling through: Austerity in the Club Med

Solidarity from the Germans

• Greek (and Irish) Haircuts within the defaults: Eurozone

• Two currencies: The euro and the medi

Does this matter to Russia?

• The EU is Russia’s largest trading partner

• It acts as a political counter-weight to the US

The EU is Russia’s largest trading partner by far

Source: WTO statistics, 20 October 2010.

Russian exports, top 5 destinations, % of total, 2009

EU is losing weight in global economic governance

Source: www.g20.org.

G8 G20

Europe’s leadership remains confused

While Russia’s leadership is clear…

But as we gently decline, we enjoy ourselves…

Source: Newsweek. The World’s Best Countries 2010.

Out of top 40 best countries to live in the world, 27 are EU

Countries by rank, according to the World’s Best Countries Ranking 2010

In conclusion

• The World’s Economic Centre of Gravity is moving East.

• The European economic model is more robust than many think, but

• The Southern European problem will have to be resolved, both in the short and longer term,

• EU needs stronger institutions if it is to survive.• Europe’s leadership is currently inadequate for

the challenges.

Europe – the lost continent?

Howard Davies

Director, LSE

ICEF

HSE Cultural Centre

29 November 2010