The sovereign debt crisis exposed the eurozone’s two tiers of economic progress – between the North and South. Despite the slow economic recovery, it’s a divide becoming more prominent.
In fact, while the South eurozone remains weak – due to deleveraging, deindustrialisation and the reduction in fiscal deficits – the likelihood is that the northern eurozone will be dragged down with it.
Certainly, the eurozone exhibits a clear divide between countries in the northern eurozone (Germany, Netherlands, Belgium, Austria, Finland) and those in the southern eurozone (France, Spain, Italy, Portugal, Greece, Ireland). This is the case in terms of each countries’ economic structure, with respect to the weight of industry, foreign trade and so forth – and is an embedded economic division that will continue indefinitely, with the North growing at a consistently faster pace than the rest of the eurozone.
With regard to the dynamics between the two divisions, there are two possible scenarios here. The first is that the North is pulling up the South. The northern eurozone has a stronger domestic demand and wages are increasing at a more rapid pace. This in turn benefits the southern eurozone, which would enjoy a higher level of exports to the North, therefore improving its competitiveness and – as a result – growing production and corporate investment. So the North is pulling the South up.
The second – more worrying – scenario is that the South is dragging down the North. Certainly, the northern eurozone is heavily economically dependent on the southern eurozone. The economy in the South remains weak, due to deleveraging, deindustrialisation and the reduction in fiscal deficits, and this is weakening the economy in the North, whose exports are declining and where, as a result, investment levels remain relatively low – meaning the South is dragging down the North.
That said, it is always possible to find exceptions. For instance, Finland’s situation has deteriorated while Ireland’s has improved. And currently, while exports (in volume terms) from the southern eurozone are growing slightly faster than those from the North, this is not due to the export flows from the former to the latter. Furthermore, it seems manufacturing production is stagnant in the South and failing to catch up with that in the North – as is the case with productive investment.
Therefore, in all likelihood, it is currently the South that is dragging down the North. Indeed, the heavy economical dependence of the northern eurozone on the South means the North is quickly affected by any economic weakness. This is apparent through the fall in North-to-South exports, which has lead to a fall in investment in the North.
Underlying causes
In order to gauge how this relationship will change in the future, we need to identify the nature of the southern eurozone’s ongoing economic weakness. First is the marked difference between respective fiscal policies. The North no longer needs to conduct restrictive fiscal policies, whereas the South still needs to reduce its fiscal deficit in order to stabilise its public debt ratio.
A second factor concerns labour markets and wages. While countries such as Germany, Austria and Belgium show nearly full employment, unemployment in the rest of the eurozone is very high, leading to slower growth and greater foreign currency-denominated debt. Given the inertia of unemployment in the South – in turn, weakening household demand – this is a situation set to last.
Thirdly, industrial concentration – the degree to which production is dominated by a few large firms – is high in the North; a factor that in turn leads to greater levels of productive investment than in the South.
Also worth consideration is the relationship between interest rates and the growth rate. Prior to the crisis, growth was higher than interest rates in the peripheral eurozone countries, and lower in Germany. Today, the situation has reversed completely: the North enjoys a significantly higher rate of growth compared to interest rates – which further reinforces its growth advantage – whereas the South suffers from long-term interest rates that are higher than growth.
What next?
Boasting almost full employment, the northern eurozone has strong domestic demand and rapidly rising wages – meaning it could potentially pull up the South. Indeed, southern exports are growing faster and its competitiveness is improving relative to that of the North – factors that could potentially lead to a boost in production and corporate investment in the southern eurozone.
That said, since 2008, domestic demand has increased faster in the northern eurozone than in the south. The same can be said of real wages over the last six years. And while export volumes from the southern eurozone are actually growing slightly faster than those from the north, investment is picking up less in the South and growth is markedly weaker.
For these reasons, we believe this divide will remain for the foreseeable future – bringing with it some severe implications. For example, we are likely to see growing political tension in the South and, in the North, the risk of increasing dissatisfaction with the euro. And as political, economic and social dissatisfaction continues, we may see greater migration from the South to the North.
Indeed, the positive scenario – in which the momentum of rising domestic demand and production costs in the northern eurozone boost exports, competitiveness and eventually growth in the southern eurozone – is looking unlikely. And as northern strengths (with regard to domestic demand and real wages) are failing to contribute to a recovery in the South, for the time being, it is the negative scenario that is unfolding: the South is dragging down the North.
