An increase in economic growth in southern Europe – combined with stagnation in the French and German economies – has led to talk of a “reversal of fortunes” in the Eurozone. Yet as Bob Hancké explains, the economic reality may be much bleaker than it appears.
It’s hard not to be even a little bit discouraged when reading about the remarkable turnaround in the fate of the southern GIPS (Greece, Italy, Portugal and Spain) in the Eurozone. On 14 January, the Financial Times became the latest to join a growing news trend analysing the recent “reversal of fortunes” (the terminology is important; see below), with Germany and France flailing and the southern states booming.
Others had already wondered if Portugal and Greece (and, by implication, the other GIPS nations) have abandoned the vicious demand-led growth model – buying goods from Germany with German capital that flows freely in Europe’s Economic and Monetary Union (EMU), thus building their economic model on credit and debt – and replaced it with an export-led model.
Many of these articles have either a disturbing moralising character or an equally problematic “naturalising” tone. According to the first, the EU, ECB, OECD and others of that ilk were right: get your house in order through tough structural reforms, and you will thrive. The second seems to see the process as part of the natural ebb and flow in capitalism: sometimes you win, other times you lose – a “reversal of fortunes” indeed. Fortune, you see, is what happens to you, not what you make happen.
Still poor after all these years
When our poorer neighbours are better off, we should be happy, of course, as am I. But these recent reports warrant a few counterpoints. First, a fact check: recent economic growth may impress, but despite their recent success, growth has not quite been enough to get the southern European economies back to where they were at the height of their growth before the great financial crisis of 2008.
It is certainly true that the pandemic hit these economies hard, like all others, but GDP also artificially mushroomed because of the inflation that followed the end of the lockdowns. Put differently: in real, inflation-adjusted terms, levels of economic activity (as opposed to rates of growth) are still below the pre-2009 peaks in most places.
The fall from grace during the financial and sovereign debt crisis, the austerity that the EU imposed afterwards and the negative real effects of the pandemic on economic growth were simply massive; a few years of economic growth around two per cent are not going to make much of a difference.
Greece, for example, is estimated to have lost 25% of output during the sovereign debt crisis, something approaching half that during the pandemic (like many others), and the contractionary ECB response to inflation chopped another few percentage points off GDP. A few years of slightly above-average growth can simply not erase more than a decade of economic collapse.
Supply-side reforms redux
Far more importantly, however, recent newspaper reports ignore a central but worrying development. Many suggest, without much evidence, that structural supply-side reforms are the root cause of the economic miracle. A recent article on Italy lists flexible training systems, small family-owned firms, niche product market strategies, supportive innovation policies and excellent brand management as the key explanations for Italy’s major export success.
Now, those reforms may well have happened. I have not studied the Italian political economy in a few years and prefer to withhold judgment on the facts. But many of these positive elements already existed during the 2000s and most of the 2010s – but without the beneficial effects. And while there may also be a burgeoning, though still weak, export-oriented political-economic coalition in Greece and Portugal, these countries’ exports (of what exactly?) have not suddenly taken off, or at least not in ways that would affect wider economic performance, not even in these small economies.
Those approaches conveniently sidestep a simple fact: much of the recent growth in Europe’s south seems to be linked to a construction boom, green energy and industrial construction and infrastructure projects such as solar, wind, the transition into electric cars with effects on their supply chains in the south and (sensible) looser post-pandemic NextGenerationEU fiscal spending.
This may look good, but it is in fact a serious shortcoming. Those of us with a long memory, who can think back all the way to the late 2000s, may recall that one of the key problems in economies like Ireland and Spain was a gargantuan property and construction boom that inflated assets and sucked in qualified labour (and therefore out of other sectors and occupations). The upshot was a deeply imbalanced growth regime based on cheap credit and asset inflation, and a collapse in the skills basis of the economy as bright young workers preferred well-paying jobs in construction over further education in advanced sectors.
Something like that appears to be happening again today: Spanish construction projects are attracting workers from Madrid to the countryside with higher wages. Anecdotal evidence for now, perhaps, but given the construction needs of the green transition – from increasing the energy efficiency of residential housing over building wind and solar farms to new plants for green products while decommissioning older brown plants – the sudden lure of the sheltered construction sector may be a Cassandrian leading indicator of crises to come.
EMU as an international monetary regime
If these supply-oriented analyses overplay the structural reforms angle and underplay the wider growth regime cum variety of capitalism angle, they also ignore the structural dimensions of EMU as an international monetary arrangement. The southern boom we see today, both in its similarities and differences, and the problems for the economies in the centre of EMU, mirrors in important aspects the north-south divide that preceded the Eurozone crisis.
Back then, Greece, Ireland, Portugal and Spain were booming while Germany and to some extent France seemed to have lost their mojo. Understanding this did not require supply-side blockages, as the economic renaissance of Germany and France in the second half of the 2000s suggests.
For in a monetary regime dominated by a conservative central bank like the ECB, the single nominal interest rate, which reflects average economic conditions in EMU, is never (or at best only accidentally) the correct interest rate for any of the individual member states. It will, on a weighted basis, always be too high for half the countries and too low for the others, thus stimulating the already booming economies and forcing economic activity down in the laggards. The result: deep and growing economic divergence.
A conservative central bank with the hierarchical “inflation first, growth later” mandate of the ECB will, all else being equal, stifle growth unless it is satisfied that inflation is fully under control (and, despite encouraging recent noises from its chief economist, most ECB governors remain very cautious). Strong economic performance in one country or group of countries therefore mechanically implies (in weighted terms) weak performance in another group of countries.
That process of divergence and lack of adjustment may not be helped by structural problems in Germany (and, perhaps, France), as Wolfgang Münchau suggests in a recent book (though he may exaggerate things, like so many books since the 1970s on the coming German crisis have done – “This time is different” is a matter of faith not of analysis). But locating the cause of weak economic performance solely on the supply side, while ignoring the structural elements of the aggregate demand regime in EMU, is simply wrong.
The idea underlying this macro regime constraint has been around for a while, in fact. The late Alan Walters, one of Thatcher’s top economic advisors (you can, sadly, not always pick your friends in these debates), raised the problem almost forty years ago when arguing against the UK joining the European Monetary System. While he may have been led by other considerations than the long-term viability of EMU, the critique of a single monetary policy for a multitude of countries is well-taken and has shown up ever since in different guises.
Those who dismiss this macro-structural argument point out that in EMU nation-states are irrelevant categories or that the structural problems are counterbalanced by equally tight complex links of solidarity. In good times – which, ironically, include periods of deep crisis because that is when, following founding father Jean Monnet, the E(M)U makes big leaps – it may seem that way. But in the period between the good times and the crises, when the contradictions are building up, divergence seems to morph from healthy diversity into destructive regime competition with xenophobic undercurrents. Sit back and wait for the Greek tabloid press to suggest Germany could sell the Brandenburg Gate or privatise boat trips on the Rhine.
First as tragedy, then again as tragedy
History never quite repeats itself, of course. Even though the underlying structural problems may still be present, the context of the current and imminent tensions is very different from what it was two decades ago. The legacy of the pandemic and the anticipation of the green transition, the new geopolitical and geo-economic order with a revanchist Russia, a resurgent China and an inconsistent US will shape a large part of this coming crisis. Yet history does shine a light on today: it may repeat after all, first as tragedy but then, again, not as farce, but as a different tragedy.
Note: This article gives the views of the author, not the position of EUROPP – European Politics and Policy or the London School of Economics. Featured image credit: manfredxy / Shutterstock.com
