Blog Post

Is struggling Europe on the right track?

The latest European Commission outlook forecasts 2014 unemployment rates above 25 per cent in Greece and Spain, in the vicinity of 15 per cent in Ireland and Portugal, but close to 5 per cent in Austria, Germany and the Netherlands. In the same year it expects GDP per capita to be almost 7 per cent above the pre-crisis level in Germany, but about 7 percent below in Ireland, Portugal and Spain, and a terrifying 24 per cent below in Greece. So the deep economic and social divide that as emerged within the euro area is expected to linger.

By: Date: February 27, 2013 Topic: European Macroeconomics & Governance

The latest European Commission outlook forecasts 2014 unemployment rates above 25 per cent in Greece and Spain, in the vicinity of 15 per cent in Ireland and Portugal, but close to 5 per cent in Austria, Germany and the Netherlands. In the same year it expects GDP per capita to be almost 7 per cent above the pre-crisis level in Germany, but about 7 percent below in Ireland, Portugal and Spain, and a terrifying 24 per cent below in Greece. So the deep economic and social divide that as emerged within the euro area is expected to linger.

Such a gulf within a monetary union cannot be sustained for very long. The same monetary policy cannot possibly fit the needs of a country in depression and another one that is at, or close to full employment. Therefore the single most important issue for the future of the euro area is whether the gap within it between a still-prosperous half and a struggling half is in the process of being corrected.    

The optimistic reading is that although there is no improvement in sight on the labour market front, things have in fact started to go better and that an adjustment process is under way. The proof, it is often argued, is that external deficits have contracted substantially (Figure 1)

Figure 1: Current-account balances in percentage of GDP

Source: AMECO, Winter European Commission forecast

It is true that the external account matters, as it reflects the balance between domestic saving and investment. Up until 2007, imbalances within the euro area had largely resulted from too low savings and/or excessive real estate investment, resulting in debt accumulation. The contraction of external deficits is a sign that a correction is under way. Second, the rebalancing is genuine: in Spain, Portugal, and Greece the deficit has been reduced by more than 7 percentage points of GDP since 2007, and in Ireland it has been turned into a surplus.

The problem, however, is that the collapse in domestic demand accounts for a large part of this improvement. Since 2007 it has dropped by about one-fourth in Greece and Ireland, and by one-eighth in Spain and Portugal. Investment in equipment – which is key to ensuring the build-up of productive capital in the tradable-gods sector – has generally suffered even more. For sure demand contraction was inevitable as these countries were living far beyond their means. No economy can permanently sustain demand growth above the growth of GDP. But what we have seen since 2007 is an overshooting of demand and domestic investment contraction. This cannot be regarded as a success.              

Table 1: Change in the volume of domestic demand

2002-2007

2007-2012

Euro area

10.8%

-3.0%

Germany

4.1%

4.3%

Ireland

32.2%

-22.7%

Greece

25.6%

-27.6%

Spain

25.2%

-12.7%

Portugal

4.7%

-12.4%

Source: AMECO, Winter European Commission forecast

News are better on the export side. In spite of a grim environment, exports-to GDP ratios have noticeably increased in all four economies. Ireland was known to be a very reactive, outward-oriented economy. But it’s not only Ireland. Confronted to a collapse of the domestic economy and a stagnant European environment, firms in Greece, Spain Portugal have turned to overseas markets and significantly increased their countries’ shares of euro-area exports to the rest of the world (Figure 2). Spain’s performance on foreign markets is especially impressive. On the eve of the euro its exports outside the EU were one-fourth of those of the French ones. They now represent almost one-half of them.

Figure 2: Shares of euro-area exports to non-EU countries 

Source: AMECO, Winter European Commission forecast

The question, to which it is difficult to give a firm answer, is which part of these exports is for-survival and which is for-profit and whether, therefore, their performance can be considered lasting. This brings us to the issue of price and cost adjustment. During the euro’s first decade, the countries that are now struggling recorded persistently higher wage and price inflation than those of the North. To recover and return to both internal and external balance they must not only close the cost gap, but actually reverse it as they have accumulated foreign debt in the meantime, and will have to record trade surpluses to repay it.

News on this front are mixed. Since 2007 labour costs have roughly stagnated in Greece, Spain and Portugal (though the mix between wage cuts and productivity gain varies from country to country) and they have contracted by 8% in Ireland, whereas they have increased by more than 10 per cent in Germany. So a rebalancing is under way. Contrary to stereotypes, for example, real wages in Greece have declined by 6 per cent per year over the last three years. The problem, however, is that prices have generally proved much more rigid. Only Ireland stands out as a country where they have declined. In the rest of struggling Europe their adjustment is barely noticeable. Firms, especially in the sectors sheltered from international competition, have kept market power and they have also increased prices in response to the rising cost of capital (Table 2).

Table 2: Evolution of GDP price deflator, 2007-2012

Germany

5.1%

Ireland

-7.9%

Greece

8.7%

Spain

3.8%

Portugal

3.6%

Source: AMECO, Winter European Commission forecast

The result is that the process of internal devaluation, as economists call it, is seriously hampered. Employees have suffered wage cuts but prices have not declined accordingly, so their loss of purchasing power is bigger than it should be, and economies have not recovered lost competitiveness, so employment, especially in the traded-goods sector, is lower than it should be.

Austerity and reforms were supposed to deliver rebalancing within the euro area. They have, as far as external balances are concerned. But in spite of visible progress on the export front and noticeable labour cost reductions, this rebalancing is mostly the effect of the same collapse in domestic demand that is creating mass unemployment. Ultimately perhaps, it will pay off. But societies may lose patience in the meantime. This should be enough to prompt a reassessment. The issue is not whether fiscal consolidation and external rebalancing are necessary – they are. It is how to make them politically and socially sustainable.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article

Blog Post

The EU is in the US trade war crosshairs. It should further raise its game

The incoming European Commission faces a dilemma on the transatlantic trade relationship, because of the unpredictable policies of the Trump administration. The EU must rally its citizens; the greater the divides between member states and EU institutions, the lesser the chances are of forging effective policies toward the United States and China.

By: Anabel González and Nicolas Véron Topic: European Macroeconomics & Governance, Global Economics & Governance Date: September 19, 2019
Read about event

Past Event

Past Event

Climate change and the role of central banks

What connections exist between central banks and climate change, and what are the resulting implications?

Speakers: Emanuele Campiglio, Paul Hiebert, Pierre Monnin, Kjell G. Nyborg, Luiz Awazu Pereira da Silva, Mario Quagliariello, Mattia Romani, Paweł Samecki and Dirk Schoenmaker Topic: Energy & Climate, European Macroeconomics & Governance Location: Narodowy Bank Polski, Świętokrzyska 11/21, 00-919 Warsaw Date: September 16, 2019
Read article More on this topic More by this author

Opinion

Germany’s Divided Soul

Eastern Germans vote, think, and feel differently than western Germans do, as the results of the September 1 regional elections make clear. To help tackle the underlying economic causes of this divide, the federal government should introduce incentives to encourage foreign investment in the east of the country.

By: Dalia Marin Topic: European Macroeconomics & Governance Date: September 13, 2019
Read article Download PDF

Policy Contribution

European Parliament

Hybrid and cybersecurity threats and the European Union’s financial system

The authors document the rise in hybrid threats and cyber attacks in the European Union. Exploring preparations to increase the resilience of the financial system they find that at the individual institutional level, significant measures have been taken, but the EU finance ministers should advance a broader political discussion on the integration of the EU security architecture applicable to the financial system.

By: Maria Demertzis and Guntram B. Wolff Topic: European Macroeconomics & Governance, European Parliament, Finance & Financial Regulation, Testimonies Date: September 12, 2019
Read article More on this topic More by this author

Opinion

Economic priorities for new EU leadership

Europe is no longer in crisis mode. However, it remains vulnerable; it is unprepared and it is procrastinating. Following European elections this May, new leaders are about to take their positions at the main European institutions for the next 5 years. They have the power in their hands to take action. But more importantly, they have the power to convene 28 states, which, if united, can play a significant global role. What are the urgent challenges that require collective European action?

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: September 10, 2019
Read about event

Upcoming Event

Oct
21
08:30

What industrial policy for the European Green Deal?

This event will be a workshop, aiming to look into the design and implementation process of the European Green Deal. Each session will be introduced by three short presentations aimed at launching the discussion among all workshop participants.

Speakers: Simone Tagliapietra and Reinhilde Veugelers Topic: Energy & Climate, European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Podcast

Podcast

Backstage at BAM19: Enhancing Europe's economic sovereignty

Backstage at the Bruegel Annual Meetings, Nicholas Barrett talks with Jean Pisani-Ferry on Europe's monetary union.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: September 5, 2019
Read article More on this topic More by this author

Podcast

Podcast

Backstage at BAM19: Priorities for Europe's monetary union

Backstage at the Bruegel Annual Meetings, Nicholas Barrett talks with Zsolt Darvas on Europe's monetary union.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: September 5, 2019
Read article More on this topic More by this author

Podcast

Podcast

Backstage at BAM19: Which priorities for the new EU leadership?

Backstage at the Bruegel Annual Meetings, Rebecca Christie talks with Guntram Wolff on priorities for the new EU leadership, the Annual Meetings and Commissioner Malmstrom's keynote.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: September 4, 2019
Read about event

Past Event

Past Event

Bruegel Annual Meetings 2019

Bruegel's 2019 Annual Meetings will be held on 4-5 September and feature the launch of Bruegel's Memos to the New European Commission.

Speakers: Lorenzo Bini Smaghi, Georg Boettcher, Laurence Boone, Niels Brab, Claire Bury, Grégory Claeys, Vítor Constâncio, Zsolt Darvas, Kris Dekeyser, Jérôme Delpech, Maria Demertzis, Baroness Kishwer Falkner of Margravine, Ambroise Fayolle, Alicia García-Herrero, Mikaela Gavas, Sven Giegold, José Manuel González-Páramo, Pierre Heilbronn, Mathew Heim, Jamie Heywood, Yi Huang, Danuta Hübner, Korbinian Ibel, Shada Islam, Kate Kalutkiewicz, Brigitte Knopf, Jörg Kukies, Bernd Lange, Päivi Leino-Sandberg, Mark Leonard, Cecilia Malmström, Stefano Manservisi, J. Scott Marcus, Ann Mettler, Ashoka Mody, Reza Moghadam, Erik F. Nielsen, Jean Pisani-Ferry, Lapo Pistelli, Lucrezia Reichlin, Joakim Reiter, Victoria Roig, André Sapir, Harriet Sena Siaw-Boateng, Maria Spyraki, Philipp Steinberg, Matina Stevis-Gridneff, Alexander Stubb, Simone Tagliapietra, Jean-Claude Trichet, Laura Tyson, Nicolas Véron, Koen Vervaeke, Reinhilde Veugelers, Jasper Wesseling, Sabine Weyand, Thomas Wieser, Guntram B. Wolff and Georg Zachmann Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Palais des Academies, Rue Ducale 1, 1000 Brussels Date: September 4, 2019
Read article Download PDF

Book/Special report

Braver, greener, fairer: Memos to the EU leadership 2019-2024

This collected volume, edited by Maria Demertzis and Guntram Wolff, focusing on the most important economic questions at EU level. The memos covering 16 different files and written by 21 Bruegel scholars, are intended to present the strategic to-do list based on an assessment of the state of affairs and the challenges that will greet the new Commissioners.

By: Maria Demertzis and Guntram B. Wolff Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Date: September 3, 2019
Read article More on this topic More by this author

Opinion

Dousing the Sovereignty Wildfire

In time, the current spat between French President Emmanuel Macron and his Brazilian counterpart Jair Bolsonaro regarding the Amazon rainforest may become a mere footnote. But other rows between collective and national interests are sure to erupt, and the world needs to find a way to manage them.

By: Jean Pisani-Ferry Topic: European Macroeconomics & Governance Date: September 3, 2019
Load more posts