Europe’s North-South economic divide - is it a matter of culture?

The Euro common currency did what it was supposed to do. It removed currency barriers, thus encouraging trade and capital flows between member countries. What was not fully appreciated at the outset was the strain this would place on the less efficient member countries.

Having abandoned their own currencies, members of the Eurozone were left without protection against excessive imports and capital outflows provided by a national currency. Before joining the common currency, they could vary their exchange rates to deter imports and encourage exports. Without such protection, the economically weaker countries (mainly the southern Mediterranean countries) soon developed major trade deficits. Capital outflows followed.

Greece was one of the first to feel the impact. Its soaring trade deficit initiated borrowing which eventually proved unsustainable. The country required a bailout and haircut of its bonds.

Portugal also required a bailout, as did Cyprus. Spain and Italy experienced major economic problems which required various forms of financial assistance from the Eurogroup.

The predominance of southern Mediterranean countries requiring financial assistance raises the question of an economic North-South divide. Is there evidence of such a divergence? This requires a comparison of the economic performance of the five southern countries relative to the EU.

Using EU data we can compare the economic performance of five southern Mediterranean countries (Spain, Italy, Portugal, Greece and Cyprus) over the period 2005-2016 to the EU average. All comparisons are in GDP adjusted for population (per capita GDP) and national price differences. (Eurostat data)

In 2005, most of the five southern Mediterranean countries had a per capita GDP which was at or near the EU average. The Cyprus per capita GDP was one percent above the EU average (at 101%). That of Greece was at 93% of the EU average. Italy had the highest per capita GDP among the five at 109%. Portugal in 2005 registered the lowest at 82% of the EU average. Spain’s per capita GDP was the same as the EU average (100%).

Eleven years later, the performance of the five southern countries had deteriorated compared to the EU average. The North-South gap had widened. Not surprisingly, Greece suffered the worst. Its per capita GDP in 2016 was only 67% of the EU average. Cyprus dropped 20 percentage points from its 2005 figure to a GDP just 81% of the EU average. Spain’s per capita GDP went from 100% of the EU average in 2005 to 92%. Portugal’s per capita GDP was again the lowest at 77% of the EU average. Italy, because of its size and change of position, is probably the country that should concern the Eurogroup the most. From a per capita GDP in 2005 significantly above the EU average it dropped over this eleven year period to 4 percentage points below the EU average.

This deterioration of the five southern countries compared to the total EU is despite much Eurogroup advice, financial assistance and Troika-led reforms. Cypriots will be familiar with most of these. They include privatisation, reducing public sector spending, improving the civil service, tax reforms, banking regulations and others, mostly of a financial nature. Although many would agree that many of these reform measures were admirable and desirable - it seems they did not close the North-South gap.

As many Cypriots will be aware, this may be partly because some of the Troika reforms were not implemented. Even so, it was naive of the Eurogroup to believe that its reforms were sufficient. Economic performance is much more complex. Other factors are also involved. These include work ethic, corruption, education, traditions, teamwork, time-keeping, political attitudes, social distinctions and other factors which taken together are often grouped under the heading of “culture”.

To the degree that these cultural factors are relevant, we should not be too optimistic about any short-term reduction of the North-South economic gap. Cultural change is by its nature a long term proposition, typically requiring decades if it is to happen at all.