“AFTER irrational exuberance, a rude awakening: new-wave and old-style enterprises alike are suffering from stunted growth,” proclaims Time magazine. A comment on how America’s economic boom has turned to bust? Far from it: the article is about how Europe’s economies are in big trouble. Recent weeks have seen a spate of such stories. At the start of the year, as the American economy sputtered, European politicians were crowing about their region’s strength and prospects, so one cannot blame Americans for jumping so quickly on news of Europe’s slowdown. But Europe’s economic outlook remains less bad than America’s; and it is certainly not so dire as to justify the current weakness of the euro.

That said, European policymakers do seem to have been too complacent. Business confidence has plunged in Germany; some economists fret that the economy is on the brink of recession. In the rest of the euro area, growth has slowed more than expected. This has triggered renewed talk of eurosclerosis. Foreign investors expect returns to remain higher in America than in Europe—so they keep buying dollars.

Yet if the economies of the euro area are in trouble, America’s situation looks far worse. Industrial production in the euro zone is still 1.6% higher than a year ago; America’s has fallen by 2.8%. Europe may, however, be less immune to a downturn in America than many had thought: one reason why Germany’s economy has stumbled is that it is more exposed to America, through trade and foreign direct investment, than are other countries in the euro zone.

Germany cannot blame all its woes on America’s downturn, though, since most are clearly home-grown. Gerhard Schröder’s government has increased the burden of labour-market regulations. Small firms face tighter restrictions on firing workers; rules on the employment of part-time workers and those on fixed-term contracts have been made stricter; and the role of workers’ councils in the management of companies has been expanded. This has cramped the growth of jobs and incomes. It is, even so, wrong to see German troubles as proof that the euro area is returning to its sclerotic ways. Even in Germany recent tax reforms promise to boost future growth, and many other euro countries have made their labour markets more flexible. This is the main reason why employment in France has risen almost twice as fast as in Germany over the past three years. In the euro area as a whole, GDP growth has held up more strongly than in Germany.

The likelihood of slower growth than in America for years to come remains the main reason offered to explain why investors prefer the dollar to the euro. But canny investors should not write off the euro area in this way, for unlike the United States the euro economies are free of the economic imbalances, such as debt and overinvestment, that risk turning America’s slowdown into a nasty recession.

America’s superior performance in recent years has also been exaggerated. Over the past five years (including forecasts for 2001), America’s growth has averaged almost 4%, compared with only 2.7% in the euro area. But taking GDP per head, a better measure of comparative performance in raising living standards, the gap narrows: 3% annual growth in America, against 2.6% in the euro area. Some economists reckon that America’s growth may be further overstated, compared with Europe’s, thanks to differing statistical methods. If so, growth rates in GDP per head in America and in the euro area may not have been that different after all. Similarly, for all the talk about America’s productivity miracle, productivity growth in manufacturing has been almost as fast over the past decade in the euro area as it has in America.

Looking ahead, productivity growth is likely to slow in America as investment in information technology (IT) slows down. In contrast, there is huge potential for Europe to boost its productivity by copying America’s IT successes and by learning from its mistakes. To the extent that America’s productivity gains come from investing in IT, there is no reason why other economies cannot reap similar gains—if (a big if) governments continue to make their markets more flexible so as to make possible the necessary shift of resources.

If the gap between America and Europe narrows, this should surely favour the euro. So why has the dollar risen to a 15-year high in trade-weighted terms, despite the sharp deterioration in its economy? The obvious conclusion is that the dollar is overshooting—and is heading for a fall.

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