Euro's house di­vided

The Pak Banker - - OPINION - Jean Pisani-ferry

THE Euro­pean Com­mis­sion's lat­est eco­nomic out­look paints a dis­heart­en­ing pic­ture: un­em­ploy­ment rates close to or above 5 per cent in Aus­tria, Ger­many, and the Nether­lands in 2014, but above 25 per cent in Greece and Spain and roughly 15 per cent in Ire­land and Por­tu­gal. In the same year, per capita GDP is ex­pected to be al­most 7 per cent above its pre-cri­sis level in Ger­many, but about 7 per cent be­low in Ire­land, Por­tu­gal, and Spain - and a ter­ri­fy­ing 24 per cent be­low in Greece. So the deep eco­nomic and so­cial di­vide that has emerged within the Eu­ro­zone is ex­pected to per­sist.

Such a gulf within a mon­e­tary union can­not be sus­tained for very long. As Abra­ham Lin­coln said, "a house di­vided against it­self can­not stand." The same mon­e­tary pol­icy can­not pos­si­bly fit the needs of a coun­try that is in de­pres­sion and an­other that is at or close to full em­ploy­ment. In­deed, the sin­gle most im­por­tant ques­tion for the fu­ture of the Eu­ro­zone is whether the gap be­tween pros­per­ing and strug­gling mem­bers is be­ing closed. The op­ti­mistic read­ing is that, de­spite no sign of im­prove­ment in the labour mar­ket, eco­nomic per­for­mance has in fact started to im­prove, and an ad­just­ment process is un­der way. The proof, it is of­ten ar­gued, is that ex­ter­nal deficits have con­tracted sub­stan­tially. Ex­ter­nal ac­counts clearly mat­ter, be­cause they re­flect the bal­ance be­tween domestic sav­ing and in­vest­ment. Un­til 2007, im­bal­ances within the Eu­ro­zone largely re­sulted from too lit­tle sav­ing and/or too much real-es­tate in­vest­ment, re­sult­ing in a grow­ing ac­cu­mu­la­tion of pri­vate debt. So the con­trac­tion of ex­ter­nal deficits is a sign that a correction is un­der way, and the re­bal­anc­ing is im­pres­sive. In Spain, Por­tu­gal, and Greece, the deficit has been re­duced by more than seven per­cent­age points of GDP since 2007, and in Ire­land the cur­rent-ac­count bal­ance has swung into sur­plus. The prob­lem, how­ever, is that a large part of this im­prove­ment re­flects col­laps­ing domestic de­mand, which has plum­meted by around one-quar­ter in Greece and Ire­land since 2007, and by oneeighth in Spain and Por­tu­gal. In­vest­ment in equip­ment - the key to strength­en­ing pro­duc­tive cap­i­tal in the trad­able-goods sec­tor - has gen­er­ally suf­fered even more.

To be sure, de­mand con­trac­tion was in­evitable in th­ese coun­tries, given that they were liv­ing far be­yond their means; no econ­omy can per­ma­nently sus­tain a rate of de­mand growth ex­ceed­ing that of GDP. But what we have seen since 2007 is an over­shoot­ing of the con­trac­tion in con­sumer de­mand and domestic in­vest­ment. This can­not be re­garded as a success.

The news is bet­ter on the ex­port side. De­spite a grim en­vi­ron­ment, ex­ports/GDP ra­tios have in­creased sig­nif­i­cantly in all four economies. Ire­land was known to be a very re­ac­tive, out­ward-ori­ented econ­omy. But it's not only Ire­land. Con­fronted with domestic eco­nomic col­lapse and a stag­nant Euro­pean en­vi­ron­ment, firms in Greece, Spain, and Por­tu­gal have turned to overseas mar­kets and sig­nif­i­cantly in­creased their coun­tries' shares of Eu­ro­zone ex­ports to the rest of the world.

Spain's per­for­mance in for­eign mar­kets is es­pe­cially im­pres­sive. On the eve of the euro's cre­ation, its ex­ports out­side the EU were just a quar­ter of French non-EU ex­ports; now they are half the French level.

The ques­tion, to which a clear an­swer may be im­pos­si­ble, is how much of th­ese ex­ports are for profit and how much are for sur­vival - and thus whether strong trade per­for­mance can be sus­tained. 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 in Europe's north. To re­cover and re­turn to both in­ter­nal and ex­ter­nal bal­ance, they must not only close the cost gap, but ac­tu­ally re­verse it, thereby gen­er­at­ing the trade sur­pluses needed to re­pay the for­eign debt that they ac­cu­mu­lated in the mean­time. The news on this front is mixed. Since 2007, labour costs have roughly stag­nated in Greece, Spain, and Por­tu­gal (though the mix of wage cuts and pro­duc­tiv­ity gains varies from coun­try to coun­try), and have con­tracted by 8% in Ire­land, whereas they have in­creased by more than 10% in Ger­many. So a re­bal­anc­ing is un­der way.

Con­trary to stereo­types, for ex­am­ple, real wages in Greece have de­clined by 6% an­nu­ally over the last three years. The prob­lem, how­ever, is that prices have gen­er­ally proved much more rigid, de­clin­ing only in Ire­land. In the rest of strug­gling Europe, price ad­just­ment is barely no­tice­able. Firms, es­pe­cially in sec­tors shel­tered from in­ter­na­tional com­pe­ti­tion, have re­tained mar­ket power and have in­creased prices in re­sponse to the ris­ing cost of cap­i­tal.

Newspapers in English

Newspapers from Pakistan

© PressReader. All rights reserved.