UK: Growth In Europe, Minding The Gaps

Last Updated: 10 June 2016
Article by Ian Stewart

One longstanding aim of the European project is to foster economic convergence and to improve economic performance in low income economies. At its simplest convergence enables poorer countries to catch up with richer ones, helped by improved cross border trade, capital flows and population movements.

For the 19 out of the 28 members of the EU who share the single currency economic convergence has a further purpose in creating a more resilient euro area.

There are some spectacular catch-up stories, such as Ireland, which in four decades has gone from being one of Europe's poorer nations to one of the richest. Clear evidence of catch-up also comes from the countries of Central and Eastern Europe which joined the EU in 2004 and 2007 after the collapse of Communism. Poland, Bulgaria and Romania have, on average, grown at three times the rate of Germany and France since the early 2000s. Recent research by the European Central Bank shows that late joiners Estonia, Latvia, Lithuania and Slovakia have recorded strong convergence in recent years.

This is partly about catch-up, but is also about slower growth in the old EU. Italy has seen the most marked deterioration in trend growth. Italy is diverging substantially, and in a downward direction, from the EU's high-income group of countries. Italy's economy is just 4% bigger today than it was 25 years ago. Over the same time the Bulgarian, Romanian and Polish economies have expanded 60%.

Countries that went on to become the founder members of the euro also saw a period of economic convergence in the 1980s and 1990s, coinciding with the deeper integration caused by the creation of Europe's Single Market.

The architects of the euro saw it as a huge step towards greater European economic and political integration. But since its inception 16 years ago the twelve nations that were the founder members of the euro area have diverged in terms of GDP per capita. As the European Central Bank has noted, with some understatement, progress on convergence in the euro area has been disappointing.

The absence of such convergence – seen, for example, in differing levels of public debt and in competitiveness across the nations of the euro area – was a crucial factor in the region's economic crisis. It, in turn, exacerbated the gap in economic performance within the euro area. Thus Germany's unemployment rate, at 6.0%, is the lowest in 25 years while unemployment in Greece and Spain is above 20%. 

Such differences are reflected in widely varying standards of living across the EU. Some of the world's richest nations are in the northern parts of Europe, in Ireland, the Nordics, Benelux, the UK and Germany. Germany and the UK have roughly similar levels of GDP per head. Incomes in the richest nations - Ireland, Denmark and Sweden – are 20% above UK and German levels.

Further south and, in particular, further east, incomes are lower. Italian GDP per head is at 72% of UK and German levels; in Portugal it is 47% and in Greece 43%. In Poland, Hungary, Romania and Bulgaria GDP per head is less than one third levels in the UK and Germany.

Another way of measuring the gap in performance is through the determinants of competitiveness. The World Economic Forum ranks countries on the basis of a wide range of indicators designed to measure wealth-creating capacity – everything from the quality of secondary education to the rule of law and the ease of setting up a new business. In a universe of 144 nations, five of the top most highly ranked economies are Northern European EU member states, including the UK. These countries are ranked close to the world's most competitive nations including the US, Switzerland and Singapore.

Southern and eastern countries come lower down the league table. Italy is in 43rd place, at around the same level as Russia and Kazakhstan and below Estonia, Lithuania and the Czech Republic which are more recent and lower income EU member states. Greece is in 81st place below developing economies such as Iran and Guatemala.

A recent research paper from the Bruegel think tank found much the same evidence of a geographical divide over the capacity of countries to innovate. The EU's measure of innovation capacity – a gauge of how well countries can generate new ideas and translate them into economic growth - shows the EU as a whole lagging well behind the US. The EU scores 81% of US levels on overall innovation, with the main culprit being far lower private expenditure on research and development.  Within Europe Germany, Sweden, Denmark and Finland are the clear leaders on innovation with, once again, scores falling further south and east.

Persistent divergence of economic performance is a huge challenge for Europe's institutions. European policymakers lack instruments to bolster growth prospects in individual countries – this is the province of national governments. In the euro area a single interest rate set for countries with widely differing economic prospects does not work for all countries. And above all, low growth and high unemployment erode public support for the EU and the Single Currency. The recent rise of eurosceptic political movements across the Continent reflects, in part, economic concerns.

Expansion has changed the EU from a club of predominantly rich Western European nations to a much broader Union incorporated more diverse and lower income economies. Even longstanding unitary states, such as the UK and US, exhibit substantial differences in regional economic performance. The EU is larger than the US, incorporates more diverse economies and is not a political union. These factors makes the task of narrowing national differences in economic performance in the EU all the more daunting. 

Over the years the EU has delivered convergence, especially in the 1980s and 1990s and, more recently, for the countries of Central and Eastern Europe. Yet the gaps remain wide and, in the case of the euro area, are getting wider. Economic and political convergence tend to go together. Progress in economic convergence is vital to the future of the European project.

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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