As the countdown to the end of the first quarter of 2006 winds down, we finally have most of the major industrial countries' growth data for the fourth quarter of 2005. Fourth-quarter growth rates ranged from glacial to exuberant. Massive infusions of government stimuli helped U.S. growth. But other economies, especially in Europe, weren't as lucky. Fiscal spending in Europe is supposed to be limited by the Growth and Stability Pact, but the major countries have ignored the agreement to the consternation of the smaller ones. The pact puts a lid on fiscal spending for European Monetary Union members but several including Germany, Italy and France have amassed fiscal deficits in excess of the 3 percent limit.
G-7 GDP growth disparity continues
After leading the way in GDP growth for 11 quarters, the U.S. gave way to Japan in the fourth quarter of 2005 when compared both with the previous quarter and same quarter in 2004. On a quarter-over-quarter basis fourth-quarter growth in Germany was virtually unchanged. However, the remaining members of the Group of Seven saw positive growth. Italy has not yet reported its data, but growth was virtually non-existent there during all of 2005. In Japan, revised GDP continues to show industrial strength which is beginning to contribute to growth. The Canadian economy continued to benefit from soaring commodity and energy prices despite the strong Canadian dollar which has had a devastating effect on many of the nation's export-dependent industries.
Europe continues to be the weak link
EMU - The European Monetary Union (EMU) which encompasses 12 national economies but relies on the big three - Germany, France and Italy - continues to lag the U.S., UK and now Japan in year-on-year GDP growth. Part of the problem is structural, especially in the labor markets. But another part of the problem is the dichotomy between fiscal and monetary policy. While the European Central Bank (ECB) is responsible for monetary policy, fiscal policy is left to 12 individual governments which do not always see eye to eye with each other or with the ECB. Fiscal restraint has been thrown to the wind in favor of fiscal stimulus. Of the big three, France performed better than either Italy or Germany until the fourth quarter, when on the year, Germany grew faster than France. EMU fourth quarter GDP was up 0.3 percent and 1.7 percent when compared with the same quarter a year ago.
Many of Germany's economic ills can still be traced back to German reunification in 1989-90, when appropriate economic policies to deal with the unification's aftermath were not developed. Progress has been made in structural reforms especially in the labor market. Exports continue to fuel Germany's growth, not domestic demand which has been, and remains, moribund. The euro's strength weakened exports to non-European Union countries and subsequently took a toll on GDP growth. But the weaker euro in the past year has helped exports to regain some of their lost footing. German GDP was unchanged on the quarter and up 1.6 percent on the year.
France has been more successful in introducing structural reforms that have promoted growth, competitiveness and employment. Despite this, the economy faltered in the fourth quarter due to weaker domestic demand. GDP climbed only 0.2 percent and 1.2 percent on the year.
Italy's economy stalled in 2003 and it continues to struggle. Third quarter GDP was up only 0.1 percent when compared with last year and up a paltry 0.3 percent on a quarterly basis. The Italian statistical office (Istat), which originally planned to move GDP to chained prices with the release of fourth quarter data on March 10th, has postponed the release until March 28th. These revisions will make Italy the latest European Union country to move to chained prices in the calculation of real (inflation adjusted) quarterly data.
UK's economy continues to be fragile as housing prices and consumer spending faltered in the wake of higher Bank of England rates. Unemployment has stayed low but inflation has lingered around the Bank's inflation target of 2 percent. But manufacturing continues to recover slowly. Britain's fourth-quarter GDP was up 0.6 percent and 1.8 percent on the year.
The following two graphs below show recent year-over-year gross domestic product (GDP) growth rates for the major industrialized economies. In the first graph are the United States, Britain, the European Monetary Union and Japan. The second graph includes the EMU's three largest economies - Germany, France, Italy - plus Australia and Canada.
Asia and Australia thrive on exports
Higher interest rates have cooled Australia's economy significantly. Previously, domestic demand had been spurred on by consumer spending and a construction boom. Low mortgage rates boosted residential construction, and that spending spilled over to more purchases of household furnishings and electrical appliances. After increasing interest rates in November and December of 2003, the Reserve Bank of Australia raised rates one more time in March 2005 (to 5.5 percent) where they have remained ever since. The RBA's rate increases have taken hold, and growth has weakened despite heavy global demand for the country's commodities. Fourth quarter GDP was up 0.5 and 2.7 percent when compared with the same quarter a year ago.
Japan's economy has finally picked up steam after hesitating in the third quarter of 2005. While the Bank of Japan has formally stated that deflation is over, not all of the necessary reforms have been instituted. Earlier growth was solely the result of exports. But now domestic demand shows signs of stirring and progress has been made on bank and bad loan problems. Financial sector strains, including the need to issue a large volume of public debt without pushing up interest rates, present formidable challenges. GDP was revised to a gain of 1.3 percent and 4.3 percent on the year.
Canada and U.S. continue on the growth path
The Canadian economy continues to benefit, like Australia, from commodity exports especially to the United States. Residential construction has slowed in response to interest rate increases by the Bank of Canada. But consumer spending, which accounts for almost 60 percent of the economy, continues to expand despite higher interest rates. Business fixed investment, which includes spending on commercial construction as well as equipment and software, soared at an 8.6 percent annual rate in the fourth quarter. Fourth quarter gross domestic product was up 0.6 percent and 2.9 percent when compared with the same quarter a year ago.
United States grew at a slower pace in the fourth quarter after a very robust third quarter. The U.S. economy has been motoring along thanks to very loose fiscal policies and despite continued Federal Reserve interest rate increases that have taken the Fed funds rate from 1 percent to its current 4.5 percent level. Exporting countries such as Japan and Germany are especially dependent on U.S. growth to revive their economies given the weakness of domestic demand. And U.S. consumers have done their part by maintaining demand for imports of consumer goods. GDP was up 0.4 percent when compared with the previous quarter and 3.2 percent when compared with the fourth quarter of 2004.
Bottom line
There are some questions going forward - can Germany regain its positive growth and can Japan continue to improve domestic demand and keep deflation at bay. Assuming no exogenous events, growth is expected to pick up in the global economy during 2006. This should help the U.S. - increased growth abroad could mean more exports to Europe and Asia, relieving some of the onus of being the sole engine of worldwide growth. The important thing for Europe and Asia is that they continue to proceed with badly needed structural reforms despite their recoveries. Japan has to find a way to normalize monetary policy while the government needs to find a way to deal with its huge volume of fiscal debt. Europe needs to continue to reform labor rules to stimulate domestic demand and take pressure off of its export sectors. And the U.S. has to find a way to finance its twin deficits so they are more manageable and less of a problem for foreign investors. At present, the deficits are being financed in a large part by Asian nations who are buying U.S. Treasuries with extra dollars earned from exports.
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