Growing Pains: Europe’s Dilemma

By Bas Bakker

(Versions in Español and Français )

As the crisis in Europe deepens, it is worth asking how it all went wrong in the first place. In the past decade there have been stark differences in per capita GDP growth in Europe. Growth rates have ranged from close to zero in Italy and Portugal to more than 4 percent in the best performers. Why do some countries in Europe grow much faster than others? And how can those falling behind catch up before it is too late?

In part, these differences reflect “convergence”. It is much easier for poor countries to grow faster than it is for rich countries because they can import technology they do not already have. It is much more difficult to grow fast if you are already rich and at the technology frontier—now you can only get richer by innovation.

But convergence is only part of the story. Some countries have grown much slower than what could be expected given how rich―or poor―they are, while others have grown much faster. For instance, Italy and Portugal have grown slower than expected, while the Slovak Republic and Sweden have grown faster.

Integration into the global economy matters

What explains these differences? Both macroeconomic policies and barriers to growth.

Heavily regulated goods and labor markets and inadequate institutions and macroeconomic policies have kept some countries less flexible, less competitive, and less integrated into the global economy than their better-performing peers.

Indeed, it is striking that better performing countries are much more integrated in the world economy than are poor performers. Strong performers enjoyed high and increasing levels of trade, both in exports and in imports, while many of the poor performers have lower and stagnating levels.

In Austria, Germany, the Netherlands, and Sweden, the share of export and import in GDP rose by about 15 percent to more than 20 percent between 1995 and 2010. The same was true for the Czech and Slovak Republics, and, to a lesser extent, Poland. At the other end of the spectrum, the export-to-GDP and import-to-GDP ratios of Greece, Italy, Portugal, and Spain stagnated over those years.

How to recover from euro sclerosis

The problem of slow growing countries in Europe is not new. In the late 1970s and early 1980s, many countries in Europe suffered from “euro sclerosis”—high unemployment and low growth. These earlier periods provide important lessons, as they show that a change in policy can turn an economy around.

Let’s take the Netherlands and Sweden. In the 1980s and 1990s, these two countries undertook sweeping reforms to boost growth after a long period of poor performance. Their experience gives us pointers to reforms that could help other countries reverse their economic fortunes.

Both countries undertook reforms only after protracted economic malaise culminated in crisis. Income per capita was falling relative to that of Germany for about a decade; public finances were deteriorating, and fiscal deficits were growing. In the Netherlands, unemployment was rising because real wage costs were too high; in Sweden growth was held back by poor performing traditional industries, the banking crisis in the early 1990s, and stifling taxes.

Both countries addressed both macroeconomic imbalances and barriers to growth. Reforms focused on the most onerous bottlenecks. In the Netherlands, a main initial goal was to restore employment, which had been hurt by labor costs, and thus the centerpiece of the reform package was a wage agreement between employers and unions.

Other tax and benefit reforms also helped create jobs and encouraged more people to join the labor force. Sweden tackled its core problems on several fronts: fiscal consolidation, tax reform, clean up of the banking sector, and an overhaul of the wage bargaining system. Both countries also reduced regulation so new companies and industries could flourish.

Although reforms spanned more than a decade and took time to yield full benefits, they were very successful―per capita income in both the Netherlands and Sweden is now significantly higher than even that of Germany.

So what are the lessons for current poor performers? 

  •  First, reforms work—but they take time. It takes time to do the reforms themselves. It takes times before their impact becomes visible—initially the economic situation may even get worse—and it takes time before the full impact is felt. But the benefits accumulate over time, and they can be significant.
  • Second, addressing macroeconomic imbalances and removing barriers to growth are both essential. If deficits and debt are not brought under control, growth is unlikely to pick up. But correcting macroeconomic imbalances without also removing barriers to growth will hardly result in sustained high growth.
  • Third, what should be reformed changes over time. As bottlenecks to growth disappear, new constraints become binding.

14 Responses

  1. The scenarios in Europe seem so horrendous we wish we all were just having a nightmare.

    What if we could wake up and find a Euro II, with all European governments, Germany included, having given their creditors exactly the same haircut, for instance 40 percent, and used the excessive hair-cut in some countries, to compensate for the insufficient haircut in others.

    Why not? The bank regulations that allowed European banks to lend to Greece against only 1.6 percent capital, and which of course helped to create Greece’s excessive debts, were not just a Greek idea but a shared European one.

    And if thereafter Europe helps to avoid a repeat… like for instance requiring bankers to put up exactly the same capital when lending to a European sovereign as it has to put up when lending to a European small business or entrepreneur… could we all not wake up, hurting a lot, but at least looking forward to a better future?

    • There was an article in the French Metro (free media) this morning. A French Think Tank said that was Europe needs is a Federation -like the USA- because, the assumed European Federation would have no debts and this will give EU Federation a € 5000 billions an it could borrow on the financial market. What do you think?

  2. Employment opportunities, good governance and trade/industry/businesses and financial/fiscal reforms are the keys to GDP growth.
    However, the most important points with regard to the economic woes of the present day weaker economies in Europe are attributable to various factors not touched upon here in this brilliant write up.
    For example, corruption is eating into the vitals of most of the dwindling economies.
    Competitiveness is absent there and lethargy together with complacency have taken root, causing inefficient growth levels.
    Some of the economies mentioned by you like Greece, Ireland, Portugal, Spain etc have often been exploited by big banks/financial institutions/money lenders/bond traders/speculators/ arm exporters and real estate barons of Germany, France and UK in particular.
    The European Union of 27 countries is lacking a central point of reference. The euro zone using euro as a single currency has been joined by 17 out of 27 countries which is not only awkward but deadly against the 17 members who have no powers to manage their exchange rates or monetary policy — why?
    Plus the dishonest credit ratings, distorted stress test mechanism adopted for measuring the financial viability of over 90 European banks in the last two years have all proved disastrous for the PIIGS economies. Plus there are many factors of exploitation by the big powers on which I can write volumes.
    And on top are the most severe and unjust austerity measures coupled with the policy to seize their valuable assets at throw away prices under duress by the EU/ECB/IMF ‘troika’.
    So, in the light of the above factors, how can you conveniently explain the causes and effects of the pains and growth dilemma of those left behind by merely drawing charts, graphs and pictorial presentations?

    • Hello,

      Economics is not a rocket science. Do not expect to find all your answers in charts.
      Myself, I think there are more unknowns that knowns, but this should not stop people to build the future of the banking system.

      Above all, I believe the rational explaination given by Bloomberg business week because the rational is simple -but not simpler-
      http://psd4us.com/723-bloomberg-businessweek-26-september-02-october-2011.html
      Greece is heavily endebted because of the bonds. Now, one need to remove this burden-and this is threatening all Europe and its project.

      Also, I visit and work in Ireland in 2000-the econonmy was very fine-there was no euro currency, but irish pound-

      I returned to Dublin in 2011- The economy is a pity- People in the streets and shops are looking abandonned-

      Ireland use to be the country of computer technology- Now, the cost of 15 minutes computer is €1 to €1.5…. (compared to France -Dublin €0.5, Germany-Bonn €0.5)

      Even, in their own industry, there is no so much enthusiasm. (and they enjoy the Euro, now)- But, other industries are the same symptoms. I found prices of good and services has increased by 25%-50%

      So, I am not saying euro is not the main cause of the European community success of failure, but there is a feel for it. (look most countries that have survived the crisis are in the EU Union, but not using it e.g. Denmark, Sweden, Norway, Swizerland, Poland,…)

      What matters is your feeling when walking in the street, and this is best to assess if a coutry wealth and health….

      My conclusion, when I heard and watch TVs to see of those youngsters unable to find jobs,…..they are resingated, it is a pity. Status Quo for Greece, Italia, Spain, Portugal,….when the economy is not growing it is very bad.

      Regards

  3. [...] Growing Pains: Europe’s Dilemma – iMFdirect [...]

  4. As President of the European network for Chief Economists in the public sector, I had the honor of the 17th and 18th October leading “European Association of Public Banks (EAPB) Chief Economist Network Meeting” in Brussels. Interest in participation was record high. The days ended with a very interesting round table where all the Chief Economists, MEP, European Commission and European Investment Bank participated. The issues discussed were: the most critical weeks and while for a hefty haircut in the Greek economy is approaching.

    What is Greece’s haircut / impairment? The participants were agreed that there is no other way out of the crisis than a real depreciation of the Greek debt. A cut of 50% was considered reasonable. Both public and private sectors are expected to foot the bill. It will be done everything possible to calm the market, avoiding speculation and trying hard to isolate Greece’s problems.

    How are our banks and the countries’ economy? By impairment increases the risk that more banks may be a worrying situation. A number of bank failures may be in Greece but the problems at risk spread to other parts of Europe, mainly to Germany and France. The macroeconomic effects likely to become apparent with increased difficulties for individuals and businesses to borrow money, which in turn affects both Europe and the countries with increased risks of business failures, rising unemployment and inhibiting growth.

    Will any country leaving the euro in a year? All participants answered no. We talked specifically about both Greece but also Germany. The political defeat would be too difficult to handle and the entire international confidence in Europe would be considerably reduced. What information will the world be after the summit Sunday at 20:00? The group had the expectation that no revolutionary answer comes tonight. It will seek to gain time to open for more discussions.

    What is the most important solutions we must invest in the new Europe, with strong growth and international, competitiveness? All were united on a number of European countries have a long way to go. As an example, mentioned Italy where it is estimated that the country faces a 10-20 year old austerity program. The key solutions that were identified were: to have a social and political will to change, more regulation / supervision, greater focus on job creation / growth, increased focus on integration / training / SME and the need to see the crisis from a strategic perspective instead of saving the local fires that occur. We called for a much longer term perspective, often with European 30-year plan, where the growth program, Agenda 2020 has been overshadowed by all the crises discussions.

    Lena Bäcker

    Enforcement Director at the Swedish Enforcement Authority/Ministry of Finance
    and
    Chairman at the EAPB Chief Economist Network

    • Dear Lena Backer,

      I can agree 450 degree with you and the particpant of the surveyon-and thank you for connecting me-
      + all the 50% debt as good estimate
      + a country not willin g to leave the EU economy, if not it would be worst,
      + …
      + and so on.

      I appreciate you conforted me in my vision of Europe today, not a Federation,…not a grouping of countries.

      I felt, apart from the EU pacts (from Mastricht 1987)….to Austerity bail out (Wen. Oct. 26, 2011) and the European Facility Safety Fund (EFSF) total estimate for the future Expected amount would be €1000billions (?)- and this is confirming the fact, that EU community is an currency/economical integration and EU is not yet ready to chnage status, for example for a more political organization, with an elected president…

      Also, very fine, Bloomberger business week said that the bonus package receive by bosses during the financial crisis and austerity crisis would have been enough, to cover all EU community country debt and even, there would be a surplus.

      The “new” Europe (new brand Europe) is about gains from comparative advantages, freedom of exchanges and economy of scales. So, these multinationals are profitable.
      So, where does the monies go -volatility, in the pipes leakage or maybe just the bonus package.

      At the example of USA, wealthy people, should ask to pay more taxes- and pay them effectively for the recovery, becuase, it they are wealthy, it is because others in the community have been naked, in the meantime.
      But, of course over the Atlantic ocean, it is impossible missions to rmove these bonus packages.

      Anyway, thank you to IMF as with have financial debt fighters.

      Look forward to hearing from you.

      Yours sincerely,

      Georges RADJOU,
      BIRD-BUSINESS INNOVATION RESEARCH DEVELOPMENT
      [BIRD CEO, MBA, DUPEBH]
      WATER AND ENERGY, FOOD & WATER SAFETY, SUSTAINABLE DEVELOPMENT
      ECOSOC N.Y.AFFILIATE

      ENC.

  5. Events of the last decade confirm that reduced government control contributes more to economic growth than excessive tightening by the authorities. Market forces, if moderately managed, can help with employment, inflation, banking sector, wage bargaining, and import/export bills that together will encourage fresh investment.

    The primary function of the government should be to providea supporting environment and avoid excessive financial and administrative regulations which will stifle initiative needed for new innovative products and services.

  6. Dear Mr Bakker,

    I found your diagram and figures interesting, and the document is very well documented.

    It goes beyond the outward shift -IMF economist Blanchard would say moving to the right- It is better than the efficient frontier curve and the opportunity costs, which is suppose to maximize production choices.

    1- Convergence: it is true, that if a country has a need for growth, it can take the opportunity of these technology to boost the country ahead -improve the growth-

    2- Growth: depends of the status of the technology and the people (formula used in management), and as you rightly said, the more growth you had in the past, the less likely it is to be in the future, but perpetual growth do not exist- 1 or 2 digits may be fine are fine. In the organization -a firm,…-, in product life cycle, the curve is strait line parallel to the time baseline – meaning the system is saturated, it has reached a roof e.g. cycle lifetime may be difficult to keep, before the grow stop, and the organization, either a product or a firm disappears eventually,..

    It is good to have these new growth like green growths, and growing in slow growing economies,….The growth needs to encompass -go beyond- the resistance to growth -these are resistances to changes e.g. taxes, regulation with various opportunity costs- and there are the speeds of changes -represented by the time baselines.
    In macro-economy, “The efficient frontier curve could/cannot be pushed beyond a certain limit.”

    3- Bottlenecks implied having country flexible planning and each and every countries, implemented differently a strategy for a growth. It ended up with 2 kind of countries slow and fast growing countries. All is linked to the lack of financial resources…

    4- Integration, maybe, I have a different viewpoint. I am not surprise good performing countries are integrating better than poor performing, for all the aboves-
    but, truly understand this performance integration worked in normal country economical life. – what do we see today, poor performers of the past e.g. BRICS, African countries and other economies- have performed better in the uncertainty or in the post recovery crisis period-their average growth rate was 3 to 6 folds higher than developed nations and the PIGS economies)-

    5- Euro-sclerosis, Swedish crisis recipe worked for Sweden -it cannot be reproduce else-wehere- Holland reduces the pains of the crisis and it worked for Holland -and not for Greece or PIGS countries -and, what I saw in your Euro sclerosis, is 2 Europes in one-
    a) North Europe, which Germany has the leadership role, better growth, japan carry trade, less unemployment, trade regulations,…which can put people at work -and also, the historical conditions of the foreign labor- influencing the working behavior and a robust financial account country correct me, if I abuse_ it is the separation between
    B) Mediterranean and Latin Europe.
    (Now you have a 3rd Europe, which are former east/communist countries.)

    In summary, I share with you those good ingredient for reforms are:

    + investment (quantity and quality)
    + quality industries (primary, secondary,…and quaternary)
    + intellectual capital (workforce, skills, property rights,…trademarks)
    + the skills of the managers and governance
    + presence or lack of country resources,
    + leadership, policies and regulations.
    + and time.

    But, all these reforms -to my viewpoints do not have to be taxing and time consuming. as, people would be defeated, if they were too long or too taxing to see these changes. Therefore, the importance of the strategies.
    So, not all is about country economies, but mainly people and their clairevoyance of the opportunities, and how they can move from there.
    Would you keep your promise to go to the moon, if you cannot return to it -and what for-?

  7. As it states in this article “it is worth asking how it all went wrong in the first place.” Well you can keep asking that question every now and then when financial problems and crisis occurs!

    Government allow more borrowing and people jump on borrowing more and more and more, but then when it is time to collect what is owed “with interest” people and governments cannot pay what they borrowed. So now we have the EU bailing each other out and the US seems to have never ending debt that might never be paid off.

    Those European countries that grow much faster and have more wealth are the ones that make products and sell to the world, the rest rely on tourism and small businesses to pump money into their economy and many thought changing their currency to the euro would make them prosper but now it seems it has only made debt.

  8. you did mention about the policies that bring in the changes.. it all boils down to the government in the end to take action and ensure that the country actually grows

  9. @Bas Bakker “it is worth asking how it all went wrong in the first place.”

    Absolutely because if not correctly and completely understood it is so much harder to correct.

    Some weeks before the Euro was launched, in an Op-Ed, I predicted the problems that could arise, with one notable exception. What I did not predict, it was just not possible for me to imagine something as dumb, was the possibility of the bank regulators in Basel allowing the banks to leverage 62 times to one, and sometimes even more, when lending to the European Sovereigns. And that my friends, is an attack that not even the most perfect monetary union could have defended itself against.

    To honestly recognize the above is a must, in order for the Europeans to understand that it was not really the Euro or Europe which should be completely blamed for the crisis, so as to avoid the self-doubts that stand in the way of the confidence they need in order to move the Euro and Europe forward.

    Of course, what Bas Bakker writes, is both correct and relevant… but on another dimension.

    • Policies bring on change; this is becoming rocket science to me.

      • Absolutely not rocket science!

        A German bank, when lending to an unrated small German business, needed to hold 8 percent in capital, but, when lending to Greece, because Greece was officially perceived as not risky, it needed to hold only 1.6 percent in capital.

        That meant a German bank, when lending to a small German business, could only leverage its equity 12.5 to 1 times (100/8) but, when lending to Greece, it was authorized to leverage 62.5 to 1 (100/1.6)

        Since a banker needs and wants to provide his shareholder with a high return on equity, upon which also the size of his bonus depends, the German banker overexposed his banks to Greek sovereign debt and underexposed it to small German small businesses.

        And the crisis ensued . . .

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