Europe may eclipse U.S. as world economic engine

PARIS -- Companies ranging from Honda and Toyota to Remy Cointreau are betting on Europe's economic recovery -- as Asia's situation deteriorates and the U.S. economy slows.

Faced with a Japanese car market that has shrunk for 14 straight months, Honda is expanding production at a factory in Britain while Toyota is building a new factory in northern France. Remy, which had grown dependent on cognac sales to Asia, is introducing new drinks to lure European consumers now that sales in Asia have collapsed.

As Japan and some other Asian economies sputter into recession, and the U.S. economy cools from its blistering pace of the past two years, European economic growth is catching up. By the end of the year growth in Europe is expected to surpass that of the United States. And unlike earlier short-lived economic spurts, this time Europe's growth is evenly distributed among consumers, investment and exports, and is barely pushing up prices. "You can't say right now that Europe is the locomotive of the world economy, it's just a large part of the engine," said Jean- Philippe Dauvin, chief economist at STMicroelectronics, Europe's second largest semiconductor maker. "By early next year, when the U.S. has inevitably slowed down, it could be the locomotive of the world economy." Banque Paribas estimates that economic growth in the 11 countries making up European monetary union will accelerate from 2.5 percent in 1997 to 2.9 percent in 1998 and 3 percent in 1999. The U.S. economy, meanwhile, is seen slowing from 3.8 percent growth in 1997 to 3.3 percent this year and 2.4 percent in 1999. Japan's economy is likely to be stagnant this year and grow just 0.2 percent next year. Many other Asian economies are expected to do even worse as banks throughout the region are sunk by bad loans. "The economic outlook for Europe is particularly good, with growth in the 2.5 to 3 percent range, high enough to generate good earnings growth but not enough to lead to inflation," said Rupert Thompson, a fund manager at Henderson Investors in London with 30 billion pounds ($50 billion) in European equities under management. In Europe, "you're looking at earnings growth of about 15 percent a year, while in the U.S. you are looking at about 5 percent and in Asia negative," he said. Asia's slowdown is being felt by U.S. companies, especially those that rely on export trade. Minnesota Mining & Manufacturing, which makes products such as Post-it Notes and Scotchgard fabric protector, said weak economies in Asia will hurt second quarter earnings. The St. Paul, Minn.-based company, which generated more than half of its $15.1 billion in 1997 revenue outside the United States, said international currency translation will reduce the quarter's earnings by more than 10 percent. Overall, U.S. exports registered a 3 percent drop in the first three months of this year, the largest decline since the third quarter of 1993, as shipments to the Pacific Rim weakened. Expectations of curtailed exports and resulting slower U.S. growth -- along with the salutary inflation effects of low import prices -- have persuaded Federal Reserve policy makers to leave the U.S. overnight bank lending rate unchanged at 5.5 percent for 15 months. No change is expected when Fed policy makers meet for two days June 30-July 1. Fed Chairman Alan Greenspan seems convinced the U.S. central bank doesn't need to change rates just yet. "The effects of the crisis in Asia will almost certainly damp net exports further, potentially moderating the growth of domestic production and hence employment," Greenspan told members of Congress last week. Asia's fallout on Europe may be more limited than on the United States. Some businesses, such as fashion company Gianni Versace and luxury goods company LVMH Moet Hennessy Louis Vuitton are seeing sales falling because of Asia. Still, only about 10 percent of France and Germany's exports go to Asia, including Japan, while almost 30 percent of U.S. trade heads that way. "I'm not very concerned by the Asian impact on European stock exchanges," said Eric Bleines, who manages the $1 billion France Growth Fund at Indocam. "The Asia crisis means a higher dollar and it means lower interest rates and that's extremely bullish for the European environment." Instead, growth in Europe is picking up as companies crank up investment ahead of next January's introduction of a common currency, the euro. And years of strong exports are finally feeding through to local economies, cutting unemployment and encouraging consumers to spend. With most European countries sending close to two-thirds of their exports to other European countries, exports are likely to hum along smoothly. "This is going to be a year when we finally see a spillover from exports to domestic demand," said Stefan Schneider, an economist at Banque Paribas (Deutschland). All that is likely to take place with low inflation, as weaker Asian currencies keep the price of raw materials lower and sharpened competition prevents businesses from raising prices. Renault, France's largest car and truck maker by sales, had to leave the price of its compact Clio unchanged when it introduced an updated version of it in March. Consumer prices are expected to rise about 1.2 percent in France in 1999 and about 2 percent in Germany. After three years of lackluster growth, the German economy is expected to gain momentum this year as falling joblessness encourages consumers to open their wallets. Gross domestic product in Europe's largest economy expanded 3.8 percent in the first quarter from a year ago, the speediest growth since eastern and western Germany were reunified in 1990. The government forecasts growth of between 2.5 percent and 3 percent for 1998, and the Organization of Economic Cooperation and Development sees 2.9 percent growth next year. In France, steel production is up 7.2 percent in the first five months of the year, and Usinor, France's largest steelmaker and Europe's second-largest, expects first-half profit to "nearly" double because of strong European demand for cars and machinery. France's economy, the second largest in Europe, is expected to grow 3 percent this year and 2.8 percent in 1999, the most it's grown in any two-year period since 1989-1990. Still, economists aren't expecting Europe's growth to match the rates seen in the United States' recent expansion, now in its eighth year. The U.S. economy grew at annual rates between 3.1 percent and 4.9 percent in the past six quarters. "The European economic recovery is solid but it will never be extraordinary," said Jean-Paul Betbeze, head of economic research at French bank Credit Lyonnais. "We seem to be capped at about 3 percent." Betbeze said the introduction of the euro, while leading to an increase in investment, will also mean a long process of mergers and company restructuring, leading to job cuts. "The euro economy is something that has to be created," Betbeze said. "Eventually, we will get down to something like three car companies and five major banks, but it takes an enormous amount of time." In the meantime, unemployment rates will remain high enough to put a damper on consumer spending. Some economists, while they see European growth picking up, don't necessarily see it outpacing the United States. "Before we had just the U.S. pulling the world economy, and now we'll have the U.S. inevitably slowing a bit and Europe entering a period of sustained growth," said Philippe D'Arvisenet, chief economist at Banque Nationale de Paris. "But it's too much to say that Europe will be the sole motor of world growth."

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