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Europe Vs. America – The Economic Dimension

How will the transatlantic relationship shape the global economy?

July 30, 2003

How will the transatlantic relationship shape the global economy?

For years now, most analysts assessing the state of the economy around the world have looked down on Europe — and up to the United States. Is that view still warranted? Or are perspectives changing in light of the economic policy pursued by the Bush Administration? Martin Hüfner, the Chief Economist of HVB Group, provides his perspective in this Globalist Interview.

There has been a lot of transatlantic infighting in the foreign policy arena. What about economic issues?

“What strikes me the most is that the United States and Europe are currently practicing two concepts of fiscal policy which couldn’t be more different from each other. In the United States, the leveraging of public finances seems to know no bounds. The federal budget deficit is rising this year by $300 billion, to a total level of $450 billion — or 4.2% of GDP. In absolute terms, that is an all-time high in the history of the United States.”

What about Europe?

“In the euro zone, in contrast, an all-out effort is being made to save, despite the generally weak economy. The euro zone's public-sector deficit has risen only slightly — to 2.8%.”

How do you explain these fundamentally different policies?

“The reasons for the different policies can be explained by two names. The Americans go by Keynes — who believed that public-sector deficits increase general economic demand purely in terms of quantity, and thus support growth.”

And the Europeans?

“The Europeans go by Ricardo. He believed that what counts most is long-term investor and consumer confidence. He thought that a purely quantitative increase in public-sector deficits could even be harmful to the long-term stability of a country. Today’s deficits have to be paid back (including interest payments) by future increases in taxes.”

So, who's right?

“If we look at the figures, the Americans appear at first glance to be right. Through an expansive fiscal policy — coupled with an aggressive monetary policy — they have managed to achieve overall economic growth that is much higher than in Europe. The Americans have one great advantage: They have shown in the past that they can turn a budget deficit into a surplus. In Europe, only few countries have achieved that.”

Do you agree with that view?

“A closer look reveals a more complex picture. The high public-sector deficits in the United States have inflated growth. But they have not resulted in the multiplier and accelerator effects one would have expected based on economic textbook logic.”

What's your evidence?

“Without the deficits, the U.S. economy this year would have shrunk by 0.6% — instead of registering growth of 2.1%. It is striking that this is the third consecutive year in which U.S. growth — corrected for the large fiscal impulses — is lower than the corresponding European growth.”

Does that worry you?

“Together with the current account deficit, the vast U.S. public-sector deficits are increasingly contributing to global disequilibria, which are straining international financial markets. Together, the twin deficits (budget and current account) amount to almost 10% of U.S. GDP. Europe, in contrast, has a public-sector deficit, too — but a current-account surplus.”

What does that mean for the future?

“The public-sector deficits in the United States will prove to be impediments to growth in the coming years, because such deficits cannot continue to grow at the same pace. And when budget deficits are reduced, or even reversed into budget surpluses, they no longer contribute to growth. Europe will not experience this impediment to the same extent — because it is not relying on a fiscal stimulus to the same extent as the United States.”

What about the dollar in all this?

“So far, the dollar has fallen 7% against the euro over the course of the year: This decline shows that the United States — as a result of the current account shortfall — needs to borrow more money from Europe than European investors are prepared to invest in the United States.”

What's your bottom line then?

“European fiscal policy does not come off so badly by comparison. If one had to choose between the two, surely the European way would be the better option for economic reasons.”