July 23, 2004

The Struggle to Get Europeans to Do Their Duty and Spend

COLOGNE, Germany - Anna Ficon spent a couple of hours on a recent Saturday afternoon dodging intermittent showers and trolling the stores on Cologne's busy Hohestrasse for a pair of summer shoes.

There was a pair of white sandals for 50 euros, or about $60. But, even in summer sale season, they had not been marked down.

So the 47-year-old preschool teacher did not buy them. Four years of sluggish growth and high unemployment in Germany, she said, had persuaded her to be more frugal.

"I rarely buy new clothes anymore,'' she said. "And when I do, I stay away from the latest fashion and look for things that I can wear for a few years.''

Across Europe, many people share her apprehension. The feeling has crimped consumer spending and helped to hold down overall growth, even as figures suggest that other components of the region's economy - notably exports - are on the upswing.

"The thing that is most disturbing is that as the economy has started to pick up, you haven't had a similar pickup in demand,'' said Michael Hume, an economist at Lehman Brothers International in London.

Marlene Kaldenbach, 52, a part-time saleswoman from Krefeld, about 30 miles north of Cologne, sees this hesitation regularly, despite longer shopping hours and other consumer incentives introduced by the German government.

"When people don't have the euros, they don't go shopping,'' she said.

In the United States, and increasingly in Britain, the average shopper might pull out a Visa or MasterCard to buy the sandals. Perhaps the debt would be consolidated under a personal loan, through a mortgage - far more widespread in Britain or America than on the Continent - or any number of financing techniques that make it easier to spend more money than one has in the bank.

But people like Ms. Ficon are shaped by a cultural predisposition to save, a tendency augmented in Germany by memories and stories of hyperinflation in the Weimar era between the two world wars. European savings rates are among the highest in the world.

In the euro zone, made up of Germany and 11 other countries, annual household savings as a percentage of disposable income average about 12 percent, about double the rate in Britain and Japan; Americans save a little more than 2 percent.

Ms. Ficon said she had never bought on credit. "I know how much income I have, and it will be the same next month as this month,'' she said. "If I can't afford something today, I can't see how I will later.''

Norbert Walter, chief economist at Deutsche Bank in Frankfurt, said in the United States, "the share of people prepared to take risks is higher.''

"There was a very specific selection of the kind of people who emigrated to America," Mr. Walter said. "All the risk-takers left, and the risk-averse people have stayed.''

Prudence arguably breeds stability. But a nation, or nations, full of hesitant spenders neither ignites economies nor spurs the pace of growth when a cyclical recovery emerges, like the one that economists forecast for Germany.

The persistent malaise in domestic demand has been a source of concern for the governments of the euro zone, where consumer spending drives about two-thirds of economic activity. Some have come out with a variety of initiatives - or gimmicks, in the view of critics - to loosen consumer purse strings.

Over opposition from German labor unions, for example, Chancellor Gerhard Schröder's government pushed back the shop-closing time on Saturdays from 4 p.m. to 8 p.m. In France, the finance minister, Nicolas Sarkozy, has proposed extending Sunday shopping hours and allowing individuals to deduct 150 euros in credit card payments from income taxes. Mr. Sarkozy has even urged French retailers to cut prices of brand-name products, from Coca-Cola to Danone, to try to stimulate spending.

Yet household spending in Germany fell in May by 2.7 percent from a year earlier, the 11th consecutive month of decline. Although consumer spending in France surged in June, economists say this had more to do with aggressive discounting by retailers in the traditional twice-yearly sales than with any real changes in economic fundamentals.

"It doesn't matter how long the stores are open,'' the saleswoman, Ms. Kaldenbach, said.

In Germany, the hollow echo in stores that are still largely empty despite the longer hours has tended to deaden the debate. Efforts to liberalize shopping hours even further by allowing stores to open on Sundays and public holidays were recently thwarted by the country's constitutional court.

Mr. Walter of Deutsche Bank said consumers were suspicious of governments trying to lure shoppers to stores instead of addressing fundamental issues like long-term unemployment.

"When high government officials start publicly urging people to spend, people think that this means trouble,'' Mr. Walter said. "It tends to provoke the opposite reaction.''

Paul van den Nord, a senior economist at the Organization for Economic Cooperation and Development in Paris, said while such measures might help stimulate spending at the margins, they are "not going to profoundly change consumers' attitudes.''

"What are needed are more radical, much stronger incentives," he said.

That is particularly the case in countries with lagging consumer optimism. A crucial index of German business sentiment fell for a second consecutive month in June, and consumer confidence in Italy fell in May to its lowest level in a decade. The French statistics office last month predicted that consumer spending would be up only 0.3 percent in the second quarter from a year earlier. The German government expects household consumption to rise 0.7 percent this year.

Mr. van den Nord and other economists suggested that efforts to revive consumer spending in Europe would need to include modernizing the mortgage markets and adopting greater tax incentives for home buyers - especially in countries like France and Germany, where mortgage interest payments are not deductible from income taxes.

Second mortgages and home-equity loans are a common way for households in the United States and Britain to enhance short-term buying power, albeit at the expense of future disposable income. For many Americans, such loans have also become a way to sustain their lifestyles during downturns.

"Of course this is risky, because it can actually push up consumption beyond sustainable levels,'' said Lorenzo Codogno, co-head of economics research at Bank of America in London. "But at the same time, it allows countries like the U.S. to obtain extra fuel for growth.''

In much of the Continent, banking regulations make it difficult, if not impossible, for households to extract added value from a mortgage through a equity loan, economists said. Moreover, in some countries, like France, the maximum amount that a household can borrow is fixed at a third of the annual net or after-tax income.

Many economists view the lack of flexibility as a missed opportunity. The value of home equity loans in the United States has climbed 45 percent since the end of 2000, to $713 billion in the first quarter of this year. In Britain, mortgage equity withdrawals soared fivefold in the period, to £15.7 billion, or $29.1 billion.

But others wonder whether Europeans would use easier credit if they had it.

"All in all, the general mind-set of people toward credit is very different in Europe than in the United States,'' Mr. Walter said. "Here we have more Scots and Swabians,'' he said, referring to people from regions known for their thrift and aversion to risk. (Swabia is a region in Southwest Germany.)

Europe's lack of a borrowing culture may hold another negative for growth: some argue that it blunts the effectiveness of interest rates as a way for the European Central Bank to influence consumer behavior. The fact that the bulk of household debt in Europe is composed of long-term mortgages, most of them at fixed interest rates and many of them difficult to refinance, compounds the problem for the bank in terms of influencing consumers.

Finally, Mr. van den Nord said, the rigidity of Europe's labor market also plays into consumers' risk calculus. "If someone loses their job in the U.S.," he said, "the probability of that person finding a new job, even after one or two years, is way higher than in Europe. So using one's home to sustain a certain lifestyle is less risky there than it is here."