The Eurozone’s winners and losers – and how to close the gap
While helpful in addressing the symptom, deflation, Mario Draghi’s quantitative easing cannot be expected to solve the Eurozone’s underlying problem – a monetary union devoid of economic union.
Solving this will take years.
The chart below tracks the winners and losers of the euro, since its introduction. It highlights how real unit labour costs have shifted as well as changes in the current account position of Eurozone policies during the single currency era.
We use the Organisation for Economic Co-operation and Development (OECD)’s estimates of a country’s unit labour costs in tradable goods, relative to its main trading partners’ (RULC). Growth in these indices then indicates a de facto real effective exchange rate appreciation and falling competitiveness, while a fall signifies a relative cut in unit labour costs and a competitiveness boost.
Those in the top left quadrant have become more competitive since the introduction of the euro and seen their current account improve. Those in the bottom right quadrant have become less competitive and seen their current account deteriorate.
The findings suggest shifts in Eurozone members’ competitiveness are still too disparate to rule out further tensions. With the escape route of currency devaluation closed off by the fixed exchange rate that is single currency membership, members have to rely on internal cost-adjustment to boost competitiveness if they are to generate GDP growth and higher tax revenues.
On this basis, one of the biggest winner has been Germany – which is helpful given it accounts for 28 per cent of the Eurozone’s GDP. Most others, however, have experienced a net deterioration since they adopted the euro.
But, the good news is Spain and Italy’s positions are now improving rapidly. France is better, though lagging. The grey blobs mark where the green blobs were before austerity kicked in, in 2010. Their estimates to 2015 in green thus suggest improvement.
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Outside the Eurozone, the UK managed to outperform by virtue of sterling’s ten per cent trade-weighted depreciation since 2000 – a route cut off to Eurozone members.
This raises hope that, painful though it is, austerity is paying dividends and that better equity markets and the narrowing in bond spreads after Draghi’s “whatever it takes” pledge are underpinned by tangible improvement.
However, it comes at significant economic and social cost. There may be a limit to how far Spain and Italy can reform, given male youth unemployment rates of 44 per cent and 39 per cent, respectively. Their real household spending is still six to ten per cent down on 2008, yet Germany’s is up by seven per cent.
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Accelerating reform may be too difficult, politically, with 2017 general elections due in Germany, France and potentially Italy and the Netherlands – especially if there’s spill-over from the Brexit vote.
Then there’s Greece, whose deflation improved competitiveness, but exacerbated its real-debt dynamics. Without debt relief, its €86bn package is only a sticking plaster, and after losing 22 per cent of real GDP since 2010, it now has reform fatigue. Within that, the IMF’s latest offering of a maximum €10.3bn gets Greece through this winter – but another Greek debt restructuring seems inevitable.
Tackling the cause of the crisis thus needs more than just quantitative easing. Yet, without it, some of the benefits to Spain, Italy and others from their competitiveness gains may be offset by a stronger euro. In short, quantitative easing could be with us for many years to come.