European Union: An Odd Time For Another Euro Crisis

Last Updated: 25 February 2015
Article by Ian Stewart

It is ironic that Greek secession from the single currency has moved centre stage just as its economy, and other 'peripheral' euro area economies, seem to be turning the corner.

Four weeks ago we wrote about the "extraordinary adjustment" that has occurred in the Greek economy over the last five years. Public expenditure has fallen by 30%, the public sector deficit has been cut faster than in any other industrialised economy and competitiveness has been boosted by lower wages and consumer prices.

Although Greece is dominating the headlines currently, Ireland, Italy, Portugal and Spain have also been through years of economic upheaval. With the exception of Italy, all of these countries received bail-outs to stave off bankruptcy, and had to endure years of austerity and policy-reform as a consequence.

A look through the data suggests that there has been important, and welcome, economic change in these economies in recent years.

Perhaps the most striking improvement has come in public finances. Government deficits have been cut most in Greece, but significant progress in repairing government balance sheets has also been made in Ireland, Portugal and Spain. Only Spain is now estimated to be running a primary deficit – a deficit before allowing for interest payments.

Improvements in public finances have helped reduce borrowing costs for the governments of the peripheral euro area economies. Irish, Italian and Spanish 10-year interest rates are now lower than in the UK or US.

Another area of improvement has been the external competitiveness of peripheral economies. The International Monetary Fund estimates that each of the peripheral economies is running a surplus on the current account of the balance of payments. This marks a significant change from the large current account deficits of five years ago. True, this is partly because demand for imports has dropped and because all euro area countries have received a boost to trade from a weaker euro. But falling labour costs and structural reforms have also boosted competitiveness and exports.

Portuguese and Spanish exports rose by more than 30% between 2009 and 2014 – roughly the same rate of growth as Germany and well ahead of the US and UK. In the eight years before the financial crisis German exports grew at almost twice the rate of Spanish and Portuguese exports.

Greater competitiveness has come at the price of wage cuts and very high unemployment. But even here there are signs of improvement. Unemployment rates in Spain, Ireland, Portugal and Greece fell through 2014. Real wages are heading up in Portugal and Spain. In December Spanish consumer confidence reached the highest level since 2001. Consumer confidence in Portugal is at its highest level since 2002.

The scale of adjustment has been unequal across the peripheral economies. Italy seems to lag, especially in shaking up its labour market. Unit labour costs – a measure of the labour cost of producing a fixed level of output – have fallen only 4% in Italy since 2009. In Greece unit labour costs have fallen 20%. Italy was the only one of the euro peripherals to not see a decline in its unemployment rate last year.

Economists have become more positive on growth everywhere in the euro area periphery other than Italy. Consensus, or average growth forecasts for Italy have not materially improved since last summer. By contrast, economists have upgraded their growth forecasts for 2015 and 2016 for Spain, Portugal, Ireland and Greece.

In the five years to 2019 Italy is forecast to be the slowest growing economy in the euro area – with growth averaging just 1.1%. Greece is at the opposite end of the spectrum, with forecast annual growth of 3.7% over the period. Only Latvia is forecast to grow quicker.

Long-term economic forecasts are famously unreliable, but Italy does seem to face particular challenges. Indeed, in many respects Italy appears to now have less in common with Greece, Ireland, Portugal or Spain than it does with another large slow-growing economy – France. France and Italy together represent almost 40% of the euro area economy. Spain, Portugal, Ireland and Greece represent only 17%. Having undergone significant, and painful, adjustment the growth outlook for these smaller economies now looks rather better than for France and Italy.

The pace of reform has been uneven, and growth remains desperately weak, but things are looking up for the euro area periphery. While Greece is attracting the headlines, the latest euro area crisis is occurring against a backdrop of a return to growth, improved competitiveness and stronger public finances.

The irony is that a Greek exit from the euro area seems more of a risk now than at any time in the last two years. Exiting the euro area now, just as the Greek economy has started to turn the corner, would be full of risks and uncertainties. Greece's government has a very strong incentive to come to an agreement with its euro area partners.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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