With the European Union (EU) heading into a double dip recession, even before the peak level of GDP of the previous business cycle has been regained (Figure 1), it is evident that the solutions adopted to deal with Europe's economic crisis have failed. But the focus of financial markets on Greece's debt crisis should not obscure the fact that the largest scale economic failures in Europe, with the most direct impact on world growth, are not in Greece, the GDP of which accounts for only 1.8 per cent of the EU’s, but in the UK, Italy and Spain. The latter economies collectively account for over one third, 34.7 per cent, of EU GDP. Furthermore these large EU economies, having failed by significant margins to regain their previous peak levels of GDP, are again turning down.
To give some idea of the relative scale of these problems it may be noted that the combined GDP of the UK, Italy and Spain is equivalent to 40.9 per cent of US GDP, whereas Greece’s GDP is equivalent to a mere 2.0 per cent of US GDP. Even the combined GDP of the three economies under EU bailout measures (Portugal, Ireland and Greece) is only 5.1 per cent of US GDP. In short, while they pose significant problems for financial markets the recessions in the peripheral Eurozone economies are simply to small to make a direct significant difference to global growth prospects.
In contrast the failures in the UK, Italy and Spain - respectively Europe’s 3rd, 4th and 5th largest economies - are on quite large enough scale to create a serious negative impact on global growth – economies approaching half the size of the US are, at best, essentially stagnant and now facing new downturns.
The aim of this article, therefore, is to place the financial difficulties in Greece against the background of these larger growth failures in Europe.
Overall trends in the EU
The overall trends in the EU’s GDP are compared to the US and Japan in Figure 1. They are shown in detail in Table 1 below.
GDP data for the EU for the 4th quarter of 2011 is not yet available – on the basis of partial statistics it is highly likely to show downturn. But on the most up to date data available, for the 3rd quarter of 2011, EU GDP was still 1.7 per cent below its peak in the previous business cycle and Eurozone GDP 1.9 per cent below, In contrast by the 4th quarter of 2011 US GDP was 0.7 per cent above its last business cycle peak. With EU GDP likely to have turned down in the 4th quarter of 2011, Europe is suffering a strictly defined ‘double dip’ recession - i.e. a fall in output before the previous peak level of GDP has been regained .
Considering the detailed data for the EU economies, plus those in Eastern Europe, in Table 1 below, the overwhelming majority of European economies have not regained the peak levels of GDP recorded in the previous business cycle. All three economies which have published official Eurostat data for the 4th quarter of 2012 (Spain, Lithuania and the UK) showed a renewed fall in output - a more detailed analysis of the groupings within the European economies is given below.
Failure of recovery in the UK, Italy and Spain
The focus of attention in the European crisis has been on small peripheral Eurozone economies – Portugal, Ireland and Greece – or on a 'Germany v the periphery' divide. But from the point of view of EU GDP by far the most serious situation is the failure of recovery in three large EU economies – the UK, Italy and Spain. These are respectively the 3rd, 4th and 5th largest EU economies. The GDP trends in the five largest EU economies are shown in Figure 2.
By themselves the peripheral Eurozone economies are far too small to pull the Eurozone economy into recession - for comparison the combined economies of Portugal, Ireland and Greece are only one eighth of the size of combined economies of the UK, Italy and Spain. The key problem in European output is that while Germany’s economy has recovered - up to the 3rd quarter of 2011 its GDP performance since the peak of the last business cycle was marginally better than the US, and France’s recovery was significant, reaching only 0.6 per cent below the pre-financial crisis peak, the EU’s other large economies had not recovered and were heading into a new downturn. On the latest available data the UK’s GDP was still 3.8 per cent below its peak in the previous business cycle, Spain’s GDP was 3.9 per cent below and Italy’s was 4.7 per cent below. Furthermore in all three economies the latest available data shows a further downturn in GDP.
Failure in the European bail-out economies
In addition to the failure of recovery in the EU as a whole, primarily due to this situation in the UK, Italy and Spain, a further striking feature is that none of the economies subject to special EU bail out programmes – Portugal, Ireland, Greece – shows any sign of recovery (Figure 3). The latest data for both Ireland and Portugal shows renewed economic downturn, while no Eurostat certified Greek GDP data has been published since the 1st quarter of 2011 – it would be highly likely to show further economic decline. This failure of recovery is despite the fact that Ireland, for example, has undergone almost four years of economic downturn and Portugal is well into the third year of downturn.
The EU bailout programmes may therefore be correctly characterised as having failed.
Widespread downturn in Eastern Europe
An equallly severe, although less reported, decline in European production than in the bail-out countries has taken place in the Baltic republics – Estonia, Latvia and Lithuania (Figure 4). The downturn in Latvia (16.6 per cent) is the worst for any European country while those in Estonia (8.6 per cent) and Lithuania (9.0 per cent) are only slightly better than Greece (9.9 per cent) and Ireland (11.6 per cent)
This crisis in the Baltic Republics, incidentally, as with the different case of the UK, shows that the European crisis spreads to far more than Eurozone – only Estonia of the Baltic republics is a Eurozone member.
In addition to the Baltic Republics economic downturn has continued in most of Eastern Europe (Figure 5) – with only Poland and Slovakia having recovered to pre-crisis levels of output (Figure 6).
The trends above leave only two large European economies, Germany and France, together with a number of medium sized ones (Netherlands, Switzerland, Belgium, and Poland) having undergone serious economic recovery (Figure 6). However, although Germany and France are the 1st and 2nd largest economies in the EU their combined GDP, at 36.2 per cent of the EU total, is only slightly greater than the 34.7 per cent of the UK, Italy and Spain combined.
In short the stagnant and declining situation in the UK, Italy and Spain is enough to essentiallly entirely offset recovery in Germany and France.
Large stagnant economies
Finally the position of the UK, Italy and Spain as large economies which have failed to significantly recover, together with smaller economies in the same situation, is clear in Figure 7.
A number of clear conclusions follow from these factual trends in Europe.
- Financial crisis may be focussed at present in Greece, but the most serious drags in output are not the peripheral Eurozone economies but the UK, Italy and Spain.
- Remaining outside the Eurozone is unlikely by itself to be sufficient to ensure economic recovery. Economic downturn in the UK, which is outside the Eurozone and has undergone substantial devaluation during the international financial crisis, is as severe as in the other large sluggish economies of Italy and Spain within the Eurozone. The non-Eurozone Baltic Republics of Latvia and Lithuania have undergone as serious declines in GDP as Eurozone member Estonia. Poland, which is outside the Eurozone, has largely escaped recession but due to large scale public investment.
- Given these trends, overcoming the financial crisis in Greece is unlikely to relaunch economic growth as the largest problems in Europe's economic recovery are located in the UK, Italy and Spain. Of these UK is not even a number of the Eurozone, while the lack of growth in Italy's economy has been prolonged - annual average GDP growth in Italy in the last decade has been only 0.2 per cent.
The overall conclusion is clear. The Eurozone crisis was predictable - the present author noted 15 years ago in 'Fundamental Economic Implications of a Single European Currency' that: '‘The process that would unfold with the creation of a single currency by this method [the Treaty of Maastricht] may be predicted with certainty. Substantial parts of the EU… will be pushed into severe recession if they join. There will be sharply deepening regional imbalances and inequalities. The malignant expressions of economic depression — unemployment, poverty, collapse of the welfare system, weakening of trade unions, racism, chauvinism, crime — will multiply. The end will be either an economic tragedy, or the deepest crisis in the history of the EU, or more probably both.’
This analysis has clearly been vindicated. But it would, nevertheless, as seen above, be wrong to conclude that the exclusive core of the problems in Europe's economy is the Euro - or to see the situation exclusively in terms of a 'Germany and periphery' situation.
The greatest drag on economic growth in Europe is its 'stagnant middle' of the UK, Italy and Spain. These three economies together are equivalent in size to Germany and France. If Germany and France are supposed to provide the 'growth engine' of Europe these three economies may be conceived of as currently providing its 'drag factor'.
Unless the situation within the UK, Italy and Spain can be resolved it is most unlikely that overcoming the economic problems in Greece will relaunch substantial European growth. For this reason, whatever occurs in Greece, the European crisis is going to be prolonged and other parts of the world economy must both take this into account and understand the more powerful factors in European economic stagnation.