Macro Perspectives

Making Europe Great Again

President Donald Trump’s promise to put America first might actually help make Europe great again.

This article originally appeared in the Financial Times on 26 January 2017.

It is difficult to understand why Donald Trump’s campaign promise to “MakeAmerica Great Again” resounded so much with so many. True, the threat ofterrorism, rising inequality and job-killing digitalization have beenbreeding anxiety for some time. However, on most metrics the U.S. economyhas been doing just fine and certainly better than Europe.

While the median U.S. household’s real income still stands below thelate-1990s peak, it has risen solidly over the past four years and willsoon make new highs. Americans still live in the biggest homes, drive thelargest cars and eat the thickest steaks. U.S. living standards, measuredby per capita GDP, are some of the highest in the world (aside from a fewspecial cases such as Luxembourg, Norway and Switzerland) and stand 50%above those of Europe and Japan. American technology, films and music shapepeople’s days and nights around the globe. The U.S. financial industry ison a sounder and more profitable footing, its housing and service sectorsare the most vibrant, and its top universities are unrivalled. Carnage itis not.

If any major economy in the world needs to be made great again, it isEurope’s. Following a decent economic performance between the euro’screation and the global financial crisis, Europe has been stumbling througha lost decade. Economic growth in the European Union has stagnated onbalance since 2008 and the unemployment rate remains twice as high as inthe U.S. As a consequence of the euro crisis, the banking sector isbalkanized and financial markets are fragmented. The move toward “everdeeper union” has stalled; separatism and a new nationalism are on therise. Brexit appears to be a taste of things to come rather than anisolated, idiosyncratic event.

Somewhat ironically, however, Donald Trump’s promise to put America firstmight actually help make Europe great again.

First, while the new U.S. administration aims to discourage imports intothe U.S. and boost domestic production, European exporters should still beable to increase their market share in the U.S. for some time. One reasonis that the dollar has strengthened and the euro has weakened since theU.S. presidential election, increasing the competitiveness of Europeanexports. If the Federal Reserve follows through with the three policy ratehikes envisaged by theFOMC’s own projectionsand the European Central Bankkeeps expanding its balance sheetand taxing banks for their excess reserves, the dollar could strengtheneven further.

Moreover, higher consumer and business confidence, as well as higher stockprices, could boost U.S. demand for both domestically and foreign producedgoods. Switching demand away from foreign to domestic goods could workeventually, but in the near term, there simply isn’t enough quality andcapacity in U.S. manufacturing to fill the gap. Most of the “Make AmericaGreat Again” hats that Trump supporters were sporting at the inaugurationwere manufactured in China or Vietnam, and it will take a while, and amajor relative price change, before we see the more affluent Americansfavor Chevrolet, Lincoln, Chrysler and Jeep over BMW, Mercedes, Lexus andRange Rover.

Second, the prospect of a more protectionist U.S. administration, togetherwith existing local pressures from populist movements, will likely provokepolicy responses in Europe aimed at stimulating domestic demand andpotential growth. The external threat to Germany’s export-led growth modelis now palpable and this will help German Chancellor Angela Merkel toovercome the opposition in her party to a more expansionary fiscal policy.In addition, while the austerity rhetoric toward Greece is unlikely tochange significantly, we may see more leniency toward growth-orientedfiscal policies elsewhere in the euro area.

Third, a more isolationist U.S. foreign and defense policy could catalyze anew joint European defense initiative. Committing to a common defensebudget, financed by joint issuance, to counter actual or perceived externalthreats is a much easier sell than other forms of fiscal union.

Taken together, relative to the optimism on the U.S. and the pessimism onEurope that is priced into markets at this stage, Europe looks set to havethe bigger potential to surprise on the upside.

All said, Donald Trump may well succeed in making an already great Americaeven greater. But the chances are that in four or eight years’ time, moreEuropeans than Americans will have reasons to say, “Thank you, Mr.President!”

The Author

Joachim Fels

Global Economic Advisor

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