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Whose Heading for the Fast Lane? The Emerging Multi-Speed Economy

After the financial crisis the world economy initially moved at two speeds – fast east, slow west. Then, as the IMF put it, came the three speed economy at the start of last year. Many emerging economies were still in the fast lane, the US gathering speed was in the middle and Europe in the slow lane. It’s a familiar image to those who drive on a UK motorway.

Today the world economy better resembles a multi-lane US highway. In any one lane cars are travelling at very different speeds. This may help to explain some of the present uncertainty, although the net effect is that the world is set to go at a faster pace this year and the next.

China is growing fast, but slowing. India has been below speed, but is now likely to go faster. The US, meanwhile, is going faster but does not have the smooth feel to its economic engine just yet.

In Europe, meanwhile, the US highway analogy is all too apparent. The UK is starting to motor, and looks set to be close to achieving the 3.5 per cent to 4 per cent growth in 2014 that I forecast at the start to the year. In contrast, the euro zone is crawling along at a snail’s pace, at a quarterly growth rate of only 0.2 per cent in the first three months of this year. In US terms this is equivalent to an annualised growth rate of only 0.8 per cent, the same as at the end of last year, suggesting it is too early to say the euro zone is gathering momentum.

The good news is that Germany is growing, up 0.8 per cent in the quarter, and that Spain seems to be going up a gear. But there is still a lot of bad news. France is stagnant and economies like Italy, Netherlands, Portugal and Finland are still contracting.

Europe is suffering from a lack of demand. Given how weak the euro zone economy has been since the crisis, it really should be growing at a strong pace by now. And it clearly needs to, if it is to make inroads into the still high rates of unemployment, particularly amongst the young.

Yet, the weakness of demand threatens deflation, where prices fall. While falling prices may sound like a good thing, it risks people and firms putting their spending and investment on hold, in the hope of buying things cheaper in the future. Deflation is best avoided.

There are many reasons for this, but it can be thought of as the ‘balanced economy paradox’. Many euro zone counties are trying to restore balance to their economy, spending less, saving more. But if too many try to do this at the same time, demand suffers. Imagine a group of friends go to the pub for a drink, but each of them decides they need to be saving more and no better time to start than now. The result: no-one is buying, so no-one ends up drinking.

Thankfully Germany is spending, with a pick-up in domestic demand. But could it do more? The trouble is Germany would argue why should the good become like the bad? In many respects, it highlights the deep rooted problem in the euro zone, where there are too many economies with different levels of competitiveness, and one size does not fit all.

The euro has been kept together in recent years by the European Central Bank (ECB), which has done a good job. In 2012 the ECB President, Mr Draghi, said he would do whatever was needed to save the euro. Up until then, there was a self-feeding downward spiral where economic problems fed political problems, in turn feeding debt problems which fed banking problems. The ECB stepped in, putting blocks in between the economic and debt problems and also between the debt and banking problems. It worked. But the latest euro zone growth figures suggest the ECB will need to do more, printing money, and helping to inject some more much needed fuel into the stalling European economy.

*Dr Gerard Lyons is Chief Economic Advisor to Boris Johnson. His first book The Consolations of Economics will be published in June.

Dr Gerard Lyons

Dr Gerard Lyons is an international economist and Chief Economic Strategist at Netwealth Investments, having previously served as Chief Economic Adviser to Boris Johnson while he was Mayor of London. He was Co-Founder of Economists for Brexit and is co-author with Liam Halligan of Clean Brexit (Biteback, 2017). For Politeia he was co-author of Banking on Recovery: Towards an accountable, stable financial sector (2016).

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