Since the beginning of the last decade, the difference in macro-economic performance between Europe and the US has been striking. With the exception of the very end of the 1990s, the Euro-zone countries have had sub-par growth, while in the US growth has remained solid, except between 2000-2001.
If one looks at the difference in productivity trends, the contrast is even more impressive. In the US, the trend rate of growth of labour productivity rebounded and increased by at least 1% annually since the beginning of the 1990’s, while in the Euro-zone it decreased by 1% over the same period. What can explain such sharp divergences?
To many, the answer lies in the supply side of the US economy being much more flexible: in continental Europe goods and labour markets are much more rigid than in the US and these rigidities are progressively eroding the Euro-zone growth potential. There certainly is some truth in this view.
But concentrating exclusively on the supply side when trying to identify the obstacles to European growth can be very misleading. It leaves totally out of the picture the huge changes that occurred in the management of the demand side of the US economy. Since the end of the 1980s, the US financial system has been greatly transformed by securitisation, and the way macro-economic policy is conducted is now totally different from what it was 20 years ago: with the help of the bond market, monetary policy has become a very efficient tool to manage aggregate demand.
What is new in the American economy is not only that the production capacities have been modernised by an increased use of information technology, but also that demand is much more ‘resilient’.
In contrast to the US, Euro-zone countries have only attributed marginal importance to the problem posed by the maintenance of growing demand. When the institutions intended to control the macro economic policies of this new economic ensemble were put in place, the fight against inflation and the mutual surveillance of public indebtedness were the only matters deemed essential. For the rest, a bet was made: according to the liberal credo, the development of supply would naturally induce a sufficient increase in demand.
The wager was all the more risky since at the same time vigorous supply policies have been adopted: within the Euro-zone competition was increased and new competitors, countries with low wages in particular, were invited to join. In itself none of these measures was bad.
Increased competition, the effects of which are enhanced by the availability of new sources of technical progress, should make the European economies more efficient, enabling them to obtain more with the same quantity of labour. But if there is nothing to ensure regular expansion of demand, what will happen?
Whenever a shock occurs - and in highly open economies, it often does - demand will progress at an insufficient pace and productivity gains will only contribute to an increase in the number of unemployed. Modernising production capacities in the Euro-zone, without at the same time improving the way aggregate demand is regulated is a dangerous venture. In that respect, the weakness and the inconsistency of the existing economic policy framework have become obvious during the last years.
The contrast between the evolution of German and Spanish domestic demand, following the burst of the stock market bubble, illustrates this rather well.
Since 2000, there has been a series of major shocks: the massive fall of the stock market, and the uncertainties associated with geopolitical tensions, has led to a decrease in spending propensities. Corporate investment in particular collapsed. In order to soften such blows, we learned from Keynes, it is necessary for some agents to increase the share of their income they spend, by borrowing or by dipping into their accumulated savings. In principle a fall in interest rates will make this happen. But the nature of the financial system and the financial situations of the agents, will also affect decisively the way such a stimulus impacts demand.
In Spain, for instance, the effect of lower rates has been very important. Household indebtedness being relatively low, banks being in a good position and the sometimes dangerous practice of offering variable-rate loans being widespread, the Spanish borrowed heavily: since 2000, domestic demand has increased at the same pace as in the US (see chart).

In Germany, on the other hand, rate cuts hardly had any effect. Having suffered severely from the stock market and economic turnarounds at the beginning of this century, German banks could not take the risk of increasing the amount of their outstanding loans; as for households, they were stuck with a high amount of debt accumulated during the 1990s at relatively high rates and were not able to renegotiate their debt at lower rates so as to ease the burden.
As a result, far from softening the blow of demand, their behaviour accentuated it: German households practically ceased borrowing and their expenditure was reduced all the more.
The difference in household borrowing behaviour broadly explains most of the difference in domestic demand momentum. Between 2001 and 2003, in Germany as in Spain, households placed an unchanged proportion of their income in bank deposits or financial assets, but in Spain the increase in their borrowing rate enabled them to spend more as a share of their income, while in Germany the fall of the borrowing rate led to the opposite happening.
In more developed economies, where public debt is already significant, it is by modulating household expenditure, in particular residential investment financed by credit, that demand can be regulated. Even if this may have been partly masked by the sharp swing in the public deficit, this is what has been happening in the US. Over the years 2001-2003, the economy was supported by an amount of additional household borrowing that was three times that of the government. And a significant proportion of the latter’s deficit being due to tax cuts in favour of the wealthiest, this swing only partially contributed to an increase in spending.
For Europe, there is a lesson to be drawn from this. Following the example of the US, there is a need
to build mechanisms enabling households to borrow without taking too many risks, allowing financial markets to redistribute the risks associated with that borrowing in order to avoid their remaining concentrated in the balance sheets of banks.
Promoting securitisation within the Euro-zone can do this. Transforming our financial systems in that direction should now be a priority: it will help make the impact of movements of interest rates across Euro-zone countries less uncertain and, at the same time, it will provide financial institutions with a new class of euro denominated fixed-income assets to put in there portfolios.
Anton Brender and Florence Pisani are economists at Dexia Asset Management. They are the authors of ‘America’s New Economy’ published by Economica (Paris 2005)