Commentary: The World Economy Could Use A Lift. Hello? Europe?

Where in the world will decent economic growth come from this year? Scratch Europe, which until recently seemed the best bet.

With Asia in crisis and the long-running U.S. expansion apparently slowing, a European recovery was supposed to pick up the slack. But instead of participating more actively in the global economy to which its politicians pay lip service, Europe seems preoccupied with national economic issues and impending monetary union. That means Continental leaders aren't taking the active role they should be in keeping the world's economic motor running.

The Asian meltdown has made the job much harder. Economic growth on the Continent, which some forecasters had expected to approach 3.5% this year, may come in at only 2.7% or so. With unemployment rates stuck around 12%, consumers aren't touching their wallets. And the real growth laggards are the heavy hitters: Germany, France, and Italy. The British boom is also slowing. "I don't see Europe or Germany being any kind of growth engine for the world economy," says Klaus Friedrich, chief economist at Frankfurt's Dresdner Bank.

MORE TENSIONS? Yet European leaders will probably feel pressure from the U.S. and Asia at the next Group of Eight meeting of industrialized nations in May to help stimulate world growth. "Sooner or later, policymakers will realize that Europe has to do more for the world economy," predicts Thomas Mayer, a Goldman, Sachs & Co. economist in Frankfurt. "That may lead to rising tensions between the U.S., Asia, and Europe."

What needs to be done is clear. Germany, France, and Italy must pare bloated governments, cut taxes, and reform labor laws to put people back to work. Reforms like these have led to faster growth in smaller nations, such as the Netherlands and Ireland. But the big economies have yet to follow.

Ironically, Europe's leaders are congratulating themselves that monetary union will be the medicine that makes the Continent more dynamic and competitive. But in the short term, the move to a single currency severely limits Europe's economic maneuvering room. Committed to keeping budget deficits at 3% of gross domestic product, governments can't cut taxes or raise public spending to boost demand unless they simultaneously make painful cutbacks in their payrolls. Politicians are loath to take such action, which in the past has provoked a harsh backlash--from today's riots in France to the left-wing political revolt that toppled the Italian government last year.

And initially, EMU could check growth in France and Germany. After European governments decide in May which countries will get into the new union, interest rates in the member nations are supposed to converge so monetary policy can be coordinated until a new European Central Bank takes over in January. But convergence means that short-term rates in Germany and France will have to rise from the current 3.3%, potentially cutting into already sluggish recoveries. And in Spain and Italy, they'll have to fall from around 4.8% and 5.8%, respectively, potentially overstimulating those economies. Some Japanese commentators are even saying that Europe should put off EMU until the world economy is healthier.

BIG WHACK. Europe also may be far too complacent about its vulnerability to the Asian crisis. Goldman Sachs figures European corporate profits will jump by only 11% this year, vs. 24% in 1997. But that projection may understate the whack to earnings that banks with heavy exposure to Asian loans will take. The Bank for International Settlements says that Germany, France, Britain, and Belgium have $81.6 billion in bank loans outstanding to troubled Asian nations. Corporate executives, meanwhile, worry about a flood of cheap Asian imports. "We'd have to decide whether or not to match their prices to protect our market share," frets Peter B. Blackford, European sales director at Goodyear Tire & Rubber Co.

A logical move for Germany, France, and Italy might be to start slashing their governments and making other reforms. But with EMU looming, that's not likely this year. The most probable scenario is that Europe--which had a $100 billion current-account surplus with the rest of the world last year--will continue to count heavily on exports for growth. As will Asia. The jackpot question: Who's going to do the buying?

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