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East/West: What Effect Would A U.S. Economic Downturn Have On Europe?

  • Breffni O'Rourke

With the apparent end of the U.S. economic boom, the question arises of what impact a downturn or even a recession in the United States will have on the European countries, both East and West. Analysts have various views of the extent of the impact, as correspondent Breffni O'Rourke reports.

Prague, 11 January 2001 (RFE/RL) -- The longest economic boom in the history of the United States seems to be over. After almost a decade of continuous growth, the giant U.S. economy is cooling. That's shown by falls in leading economic indicators, by declining figures for retail sales and by dwindling manufacturing activity. The recent decline in stock prices is but one indicator of falling investor confidence.

So far, the experts can't agree on the extent of the downturn. The optimists say they expect continuing growth, though at a lower level, while the pessimists predict a full-blown recession, which some say has already started.

The chief economist of the European Central Bank, Otmar Issing, was quoted today in the Handelsblatt as saying his bank is expecting a weakening in growth in the U.S. this year. But Issing says the ECB does not expect a recession in the U.S.

Economists define a recession as two consecutive quarters of economic contraction, something the U.S. has not seen in about 10 years. At one point last year, the U.S. economy was growing at a rate of almost 6 percent a year, before slowing to around 2 percent before year's end.

One thing however is sure: the American economy is so big that when it turns down, most of the rest of the world feels an impact in one way or the other. Jens Dallmeyer, an analyst with Deutsche Bank Research in Frankfurt, puts it this way:

"A hard landing in the U.S. economy looks more likely, or actually the most likely scenario, and we [at the Deutsche Bank] are just in the process of revising our forecasts on all major economies in the world. But the direction is clear: we are revising downward, and it is certainly an impact which will be felt in economic performance and also financial markets in Western and Eastern Europe."

There is no general agreement on the extent of the impact on Europe. One senior economist, Adolf Rosenstock of Nomura International, feels many Europeans underestimate the likely knock-on effect. He say they reason that the European Union's single market and the single currency have created a bigger economic entity "that is much less dependent on the outside world than the individual parts were in the past."

But he is cautious about carrying that reasoning too far, saying American economic growth has provided the opportunity for European companies to sell more and thus build up their own prosperity:

"Looking at growth, export growth as such, for the last two years, the U.S. economy has made the difference [to European companies], meaning that it was the marginal growth that mattered most, to kick-start (Western) Europe back into recovery in 1999 after its mid-term weakness."

An example of this is the German car industry, which was able to take advantage of the record low levels of the euro currency compared to the dollar to achieve unprecedented foreign sales last year, particularly in the United States. EU manufacturers and exporters in other sectors have similarly also benefited. Dallmeyer of Deutsche Bank, however, notes that the exposure of the Europeans to the U.S. economy is not so great in statistical terms:

"For Euroland (that is, the 12-nation euro common currency zone) the direct trade links with the U.S. are not that significant. For example, they are...smaller than with Canada or Latin America, but still, around 10 percent of Euroland exports are to the U.S., and it certainly would be felt in the growth performance of the euro area, and it is certainly something the East European countries would feel in their export performance as well."

Despite the risks to Europe posed by the U.S. downturn, Dallmeyer said it's likely that growth in the EU would continue this year at "a fast clip". For that reason, he says, the impact on Eastern Europe -- which economically is closely linked to Western Europe -- should be limited. Another possible positive factor is that, if the U.S. market becomes less attractive, investment capital flows could be drawn away from there in favor of Europe. This would diminish the initial impact of a downturn in direct trade with the United States.

Rosenstock of Nomura remains cautious. Returning to the perception that the U.S. boom has provided what he calls a profit "cushion" for EU companies, he says this has important implications for investment in the East. He says:

"For expansion there [in Eastern Europe] and for expansion into a more risky environment, you need to have a good cushion at home, that means a solid profits base from which you can 'dare' to invest in risky assets."

In other words, if this cushion is deflated by doubts about the U.S., then EU investment in the East could decline.

The same goes for U.S. foreign investment, which Rosenstock sees as likely to be more risk-averse in the event of troubled times at home.