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News : EU Economy Last Updated: Jun 24, 2015 - 11:50 AM

Greece and other poor countries in Euro Area will not become rich
By Michael Hennigan, Finfacts founder and editor
Jun 24, 2015 - 8:22 AM

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German-Greek goods trade from 1980 Source: Washington Post

Greece and other poor countries in the Euro Area will not become rich unless there is an economic miracle in Europe similar to the catch-up period of 1950-1973 when Southern Europe grew at a 4.5% annual rate.

Absolute economic convergence has been a mantra of policymakers in Europe for decades but it's generally a myth while the evidence shows that it is also an illusion in emerging economies — when Chinese data is stripped out.

There is no magic formula or easy path for joining the club of rich nations and convergence if it happens at all is usually with neighbouring countries

A quarter century after German reunification economic output in the former Communist East is about 70% of that of the former West Germany.

Last April Andalucía, the region of Southern Spain, that includes the Costa del Sol and the cities of Seville, Granada and Córdoba, was reported to have Spain's highest unemployment rate at 34.8%. When Spain's overall rate was 21% in 1997, the region's rate was over 30% and with the olive oil industry being the main employer, it's not going to converge anytime soon towards Catalonia, one of Spain's richest regions. Neither does any sane person expect the Mezzogiorno (Southern Italy) to converge towards the economic level of Lombardy (Northern Italy).

Fast economic convergence is a myth in Europe and in emerging economies

In the period from the launch of the euro in 1999, there was no significant sustainable growth in Italy, Spain, Portugal, Greece and Ireland.

Italy's GDP grew by only 3% in 2001-2010; in 2012 Portugal's output was lower than in 2001; Greece's imports surged, fuelled by credit growth and both Spain and Ireland had huge housing booms.

In 2006, Spain had about 800,000 new home starts — more than Germany, Italy, France and UK combined.

Italy, Spain and Greece had run trade deficits with Germany since at least 1980 and these widened after the launch of the euro.

The traditional industries of Southern Europe such as textiles and shoemaking were impacted in particular by Chinese competition while they also struggled to compete against the former communist countries that joined the EU in 2004.

Marco Annunziata, an Italian economist, commented in 2012: "Implausible as it sounds, Italian voters have put up with an average youth unemployment rate of 30% for the last 40 years; Spanish voters with a rate of 32%. Italy experienced 'strong' economic growth during 1994-2000, with GDP rising at an annual average of 2%. During this boom period, the youth unemployment rate still averaged 33%. In other words, one young person in three was unemployed when the economy was at its strongest. The rate never dropped below 20%.

Spain’s economy grew at an average of 3.6% between 1995 and 2007. During this impressive run, the youth unemployment rate averaged 28%; it was below 20% for just three years, with a 'best performance' of 18% in 2006."

European export performance mainly dependent on firm structure

European export performance is mainly dependent on firm structure rather than macro policy in a country. Research compares other European countries to Germany as a benchmark. While local issues such as taxes and costs do have an impact, the main factor in success in exporting are firm size and sectors of operation. If the industrial structure (in terms of firm size and sectors) of countries like Italy and Spain were equal to that of Germany, the value of the total exports of Italian and Spanish firms would rise considerably — by 37% and 24%  respectively.

A paper by Bruegel, the Brussels think-tank, says that the evidence indicates that the main differences between countries are dictated by their industrial structures. Similar firms behave similarly across countries, but Germany has a structure that favours the internationalisation of its economy to a much greater extent than Spain or Italy. In particular, the greater presence of medium and large firms in Germany means that the German economy has a greater international dimension.

Firms with around 50-100 employees contribute greatly in export terms. It is medium-sized firms that make up the backbone of export performance for most European countries.

Bruegel paper

Policy brief on paper

Economists at UniCredit, the Italian bank, wrote in a research note this month: "In line with the average Italian firm’s structure, exporting firms are also small: 90% of exporting firms employ less than 50 workers. However, the country’s export capacity is concentrated among its large firms. Exporting firms employing more than 50 workers represent 10% of total exporting firms, but they account for 60% of total exports. Moreover, data show that firms with more than 50 employees generate more than 40% of their turnover abroad, while this share drops to 25% for firms with less than 20 employees."

What should a country like Greece do?

Martin Wolf, the chief economics commentator of The Financial Times wrote in 2011 on long term solutions for the euro crisis: "Nor, as so many suggest, is some sort of fiscal union the answer. True, if creditworthy members were to transfer resources to the uncreditworthy on a large enough scale, the Eurozone might be kept together. But, even if such a policy could be sustained (which is unlikely), it would turn Southern Europe into a greater Mezzogiorno. That would be a calamitous outcome of European monetary integration."

Within the euro system, a country like Greece not only will need debt relief in the long-term, it will be saddled with large public pensions for many years — while public staff numbers are down to about 700,000, there are about 500,000 public staff pensioners.

Greece is also ageing and its fertility rate in 2012 was 1.34 compared with a stable population rate of 2.1 to 2.2. The fertility rate had been improving in the years before the recession.

A competent government that is economically literate would have to seek solutions to ensure that the country lives within its means while developing policies to keep talented people in the country who would help to diversify Greece's exports and improve the dismal record in attracting foreign investment.

Europe's Worst Exporter: Poor export performance of Greece

Greece’s tax burden is well below the European average even after rising in recent years, Mario Draghi, ECB president, wrote in a letter to a Greek politician released in January by the ECB.

“The tax burden-to-GDP ratio in Greece (including actual social security contributions), at 34.2% in 2013, remains well below both the euro area and the EU-28 average despite some increases in recent years,” Draghi wrote in the letter, dated Jan. 15, to European Parliament Syriza member Kostas Chrysogonos.

Ireland's burden is at about 35% of GNP.

Eurostat reported this week that Greek consumer prices in 2014 were 86% of the EU average compared with 81% in Portugal, 56% in Poland and 54% in Romania.

Remaining within the euro will need discipline and a time horizon for policies to show results in up to 20 years. Outside the euro, discipline would also be an imperative — in particular to improve prospects for investment.

The improvement of inward investment flows is crucial as Ireland has shown that developing an indigenous exporting base is very difficult.

Irish Central Bank research shows that despite Ireland’s reputation as one of the world’s most globalised economies, 64% of private sector workers are employed by indigenous non-exporting firms, with 56% working for indigenous, non-exporting SMEs. The economists say that these numbers highlight the importance of domestic demand for sustaining and generating employment, and suggest that an export orientated growth policy may not have as large an impact on number of people employed as might be expected.

Only 3% of Irish SMEs (small and medium size firms with up to 249 employees) are active in manufacturing, whereas the equivalent figure for the EU is 10% according to European Commission data

Overdependence on FDI (foreign investment) in Ireland coincides with low patenting, high professional fees and a public policy that results in the majority of the private sector workforce in the rest of the economy having no occupational pension coverage.

It may also be surprising that despite the hype, Israel's successful high tech sector is not a jobs engine.

A country does not have to be among the rich as long as it's run on a fair and equitable basis.

On Tuesday we reported that in 2014 that the typical Irish standard of living was below the Euro Area average, the Italian level, and close to the levels of Spain and Cyprus.

Irish standard of living in 2014 below Euro Area average, Italian level; Prices 5th highest in EU28

Irish Export Performance: Myths and reality - Ireland is a poor exporter

Centre for European Reform: The euro is no place for poor countries

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