“Europe is back!” is the new, though cautious, market mantra. Certainly, Europe will ultimately recover, but it will be a different Europe. Current hopes are inflated, as evidenced by the erosion of Southern Europe.
The second quarter GDP figures for the euro-area economies indicated growth, for the first time in 18 months. Some fund managers and market observers argue that positive new developments could unleash a long-term rally for the continent. It’s time for U.S. investors to revisit Europe, says Wall Street. New data points to recovery, albeit a rocky one.
While there are some signs of possible recovery, Europe’s debt crisis has not gone away. The record bank rally in Southern Europe is unsustainable and likely to end. There are still critical economic and political challenges ahead.
Starting in the late fall, the U.S. Federal Reserve will begin to unwind its quantitative easing (QE), while Washington must cope with its $17 trillion debt burden. The U.S. economy may soon be ready for a gradual, multi-year exit from QE. Southern Europe certainly is not.
And yet, current forecasts portray 2013 as the magical year when everything will turn for the better.
From painful contractions to devastating depressions
In the past year or so, the backlash against austerity in Southern Europe has resulted in policy shifts, which, in turn, have supported greater stability, less severe contractions and an improved sentiment across the region. None of these gains indicate a major turnaround, but alleviation of single-minded austerity measures that have added to European challenges.
Despite the shift from the conservative Sarkozy to the socialist François Hollande, the competitiveness of France continues to erode. While Paris is slowly moving toward reforms, it is lingering in contraction and can hope for weak growth in 2014, at best.
Italy has been ridden by contraction for nine consecutive quarters. Enrico Letta’s government has been strong enough to stay in power, but too weak to achieve major changes. The more flexible approach to austerity across the Eurozone has benefited Italy and may allow Rome’s exit from the excessive deficit procedure (EDP) in 2014. But Italy suffers from structural challenges, which translate to continued decline of industrial production and the end of the Letta government by 2014.
After half a decade of recession, Spanish conditions are now bad but not devastating, as the austerity obsession has given way to more realistic policies. Nonetheless, those policies started a mass emigration last year and will continue to boost debt ever higher. Despite resilient exports, weak growth will contribute to increasing economic and political challenges.
In Portugal, the recession will continue until 2014, which means that unemployment will remain close to 20 percent. In July, the resignation of two ministers led to a new cabinet. Greater flexibility in austerity measures and rising sentiment are softening the contraction impact.
In Greece, the contraction was 6.4 percent of the GDP in 2012 and will remain at 5 percent in the ongoing year. The country will be in recession well over the mid-2010s, despite additional funding by Brussels. Unemployment is over 26 percent. Political turmoil is likely to increase toward 2013/2014. A government collapse could pave way to the radical left coalition Syriza, as the leading political party.
Despite the impending German elections and expected political turmoil across the southern periphery of Europe, the Eurozone is suffering a lost decade, which could have been avoided with more sensible policies.
During the past half a decade, prosperity levels, as measured by per capita incomes, have stagnated or fallen across Southern Europe. In this way, they have amplified the historical trend line.
In 1980, the prosperity levels were not that different in France, Germany, and Italy. In contrast, per capita incomes in Spain and Greece were barely half of that in France. In turn, the Portuguese were far behind most of Southern Europe –barely a fourth of French per capita income.
At the turn of the 1990s, French prosperity surpassed that of Germany, which was coping with the costs of re-unification and. While the two had almost identical prosperity levels until the global recession in 2008-2009, France has trailed behind Germany thereafter. By 2018, average GDP per capita will be almost $49,000 in Germany but less than $48,000 in France. The impending German elections and French economic policies will determine whether the difference between the two shall increase or decrease.
By the end of the 2010s, a new hierarchy will prevail in Southern Europe. In France, per capita income is likely to be slightly behind that of Germany. In turn, income per capita in Italy (80% of French GDP per capita) and Spain (70%) will fall behind.
Before the global recession, prosperity levels in Greece and Spain were not that different. However, the past half a decade has been devastating in Greece. By the end of the 2010s, Greek per-capita income will be close to that in Portugal. In these two countries, prosperity will be barely half of that in France.
Halved world share
In the global economy, the relative share of Southern Europe is likely to halve to about 6 percent between 1980 and 2018, as measured by GDP based on purchasing-power-parity share of world.
In France, it means a decline from less than 5 percent to less than 2.5 percent of the world total. In Italy, the decline has accelerated ever since the mid-1990s and is steeper. The same goes for the tiny economies of Greece and Portugal, respectively. Only in Spain, the relative decline has been somewhat slower.
In these countries, harsh austerity regimes, coupled with inadequate short-term fiscal support and insufficient pro-growth policies, have contributed to the challenges, as evidenced by excessive debt. In 2013, it is likely to soar to 180 percent of the GDP in Greece, while hovering over 120 percent in Italy and Portugal. In Spain, it is currently 85 percent but will soar to more than 110 percent by 2018 – thanks to strict austerity and weak growth.
At Brussels, the current forecasts – including projections of per capita income, debt, unemployment – are predicated on the idea that 2013 is the year of the great turnaround, when debt will start to decline, recovery will broaden, per capita incomes will climb and high unemployment rates are expected to decrease by some 20 percent by 2018. These gains are anticipated, even despite the impact of aging populations on productivity and growth, and thus on prosperity.
In reality, Southern Europe is coping with long-term erosion, which has been compounded by excessive reliance on austerity, at the expense of fiscal support, pro-growth policies and structural reforms. There is no easy way out anymore.
A shorter version of this commentary was published by EUobserver as “The Erosion of Southern Europe” on August 28, 2013.
Dr. Dan Steinbock is Research Director of International Business at India, China and America Institute (USA) and visiting fellow at Shanghai Institutes for International Studies (China) and EU Center (Singapore). For more, see http://www.differencegroup.net.