How much more economic divergence can the Euro area withstand?

One of the original promises of the Euro project was that it would lead to economic convergence amongst the member nations. Here are the words of the then ECB President Wim Duisenberg from Prince’s favourite year 1999.

I believe that the euro need not be a factor of division of Europe but rather will have the potential of becoming an instrument for accelerating its integration

I guess we all may be forgiven for wondering if he left the letters dis out in front of the word integration! But wait there was more.

The euro, in particular, will be a strong and stable currency that will foster further economic and financial integration among member countries, thereby completing the internal market.

How did this “integration” work out for Greece,Ireland and Spain in particular? We see a group of countries whose economies had a housing boom and then bust because the Euro area interest-rate was in essence set for Germany and not them. Sadly Portugal never had a boom at all but in economic terms did then manage a bust.

Oh and as it is Friday let me provide a little pre weekend humour.

From the start of Stage Three, all EU countries – both those participating and those not participating in the euro area – have to avoid excessive deficits.

How can it be avoided that a country not entering the euro area from the start is “left out in the cold”,

Today’s reality is very different

However readers of this blog will be aware that in fact we have seen increasing divergence according to the official data. One of the divergences I have discussed several times before is one which is right at the heart of the Euro area project which is the Franco-German axis. Let me show you todays economic growth or GDP data for these two countries released this morning.

The German economy gained momentum towards the end of 2014. In the fourth quarter of 2014, the gross domestic product (GDP) rose 0.7% on the third quarter of 2014 after adjustment for price, seasonal and calendar variations.

It was a top and tailed year for Germany which had good growth at each end and flatlined in the middle leading to the overall result shown below.

The Federal Statistical Office (Destatis) also reports that this has led to a +1.6% increase (also when calendar-adjusted) for the whole year of 2014, which is even slightly higher than the provisional result released in January.

So solid if not spectacular so now let us examine a matching set of data for France.

In Q4 2014, GDP in volume terms increased by 0.1%. Over the year, GDP rose by 0.4% as in 2013.

Intriguingly the French statistics office takes the time to tell us this.

GDP growth in 2014 Q3 is still estimated at +0.3%.

It is almost as if they feel that such a number needs continual re-affirming. Also there is another troubling feature of these numbers for France and it comes from the area of investment which is recorded as CFCF.

Over the year, GFCF stepped back: –1.6% after –0.8% (in 2013).

So we see another year where Germany has outperformed France and if you think that this is insignificant then consider that compound interest even at a rate of 1% or so builds up over time and we have had several years of this already. The credit crunch pattern is that Germany contracted by more than France initially but the rebounded much more strongly but after a weak patch for both Germany looks to be pulling away, especially if we allow for the fact that the recent French growth has been based on government spending.

Putting that another way Germany is pretty much running a balanced budget whereas France has a fiscal deficit which was 4.5% of GDP at the end of the third quarter of 2014. That is one and a half times the 3% of the Stability and Growth Pact which Wim Duisenberg was boasting about in the speech quoted from above.

What about the divergence between Italy and Spain?

Analysing economic growth in Italy has become sadly easy in these times as there has not been any! Actually as today’s data hints at the overall picture is regularly worse than that as we regularly see falls.

In the fourth quarter of 2014 the seasonally and calendar adjusted, chained volume measure of Gross domestic product (GDP) remained unchanged with respect to the third quarter of 2014 and decreased by 0.3 percent in comparison with the fourth quarter of 2013.

By contrast Spain has rebounded quite strongly from its housing bust which caused an economic slump. It is much more prompt with such data and released this at the end of January.

The Gross Domestic Product (GDP) generated by the Spanish economy registered a 0.7% variation in the fourth quarter of 2014, as compared to the previous quarter.

The annual variation of the GDP in the fourth quarter 2014 was 2.0%, against 1.6% in the third quarter.

Since the beginning of 2013 the quarterly growth pattern has shown steady improvement in Spain. By contrast Italy has not had a single quarter of actual growth with its best effort being that of stagnation. Indeed the last fourteen quarterly growth reports from Italy have shown stagnation or worse. A negative rate of annual economic growth has been recorded for the last thirteen quarters. All this comes on the back of a poor pre credit crunch performance from Italy.

If we move to the government finances statistics that the Euro area so loves then Eurostat’s new graphics tell us that the national debt to GDP ratio was 128% for Italy and the end of 2013 and for Spain it was 92%. If we factor in that the Italian economy has shrunk consistently since then and its government has run a fiscal deficit I will leave you to draw your own conclusions. Whereas Spain is recording some growth creating a different dynamic.

There is a cautionary note here which concerns how inflation and in this instance disinflation is being recorded by the official deflators. Many countries have what might be called issues here but the Spanish series has been how can I put it inconsistent and erratic in my opinion.


This is of course the clearest case of economic divergence as it plunged into an economic depression where economic output and wages collapsed. The official story is one of Grecovery so how is it going?

Available seasonally adjusted data indicate that in the 4th quarter of 2014 the Gross Domestic Product (GDP) in volume terms decreased by 0.2% in comparison with the 3rd quarter of 2014, while it increased by 1.7% in comparison with the 4th quarter of 2013.

So it contracted again! Against that it has expanded over the past year. As I have explained on twitter today if you consider the size of the fall then this is not much of a bounce-back is it? Especially if we allow for the recent quarterly decline.


The Euro area overall has produced quarterly growth figures of 0.3% and annual ones of 0.9%. So another period passes where those nations “in the cold” as Wim Duisenberg boasted have outperformed those in the warm of his promises. So whilst I welcome any growth as it is badly needed we see that there is in fact extraordinary divergence underlying it which is getting worse on so many levels. I note that the physicist Gemma Godfrey has labelled it “Splitting at the core” but it is splitting pretty much everywhere in my view.

So there you have it. My financial lexicon for these times will define convergence as a splitting apart.

The Economist

As I do not subscribe I cannot read the underlying article but it is tweeting this fairly regularly under the @EconEconomics label.

Has the Bank of England chosen the wrong target for inflation in Britain?

Whereas the 2012 paper on inflation targeting on the Bank of England website tells us this.

in three cases, Norway, South Africa and the United Kingdom, the target is set by the government


14 thoughts on “How much more economic divergence can the Euro area withstand?

  1. Great column, Shaun. With regard to the countries where the government sets the inflation target, arguably Canada should be part of that list as well. In his memoirs, “Making Money”, former Bank of Canada governor John Crow wrote: “The inflation targets that now exist… have from the start been formally ‘agreed’ with the federal government. Indeed, the original proposal for inflation targets came from the government, and I knew very well at the time that in engaging in this exercise, the Bank was undertaking something with long-term implications as to how and where initiatives over basic decisions for monetary policy were going to be taken. It is telling that while the monetary aggregate targets that existed in the late 1970s and early 1980s had not been announced in the budget or in any joint statement but rather had been set forth by the Bank alone, inflation targets have been the subject of joint announcements from the start.” And he added: “In the periodic business of agreeing to reset the targets, the minister demonstrably has the upper hand.”

    • Hi Andrew and thank you

      I always wonder with such policies what happens should there be disagreement? In this case between the Canadian government and the Bank of Canada. Surely the government would win out which reinforces your argument. It could however lead to confusion and contagion and is an unwise position to be in.

      The UK is like this with its foreign exchange reserves where some (unspecified) is under the control of the Bank of England and some is under political control. I have suggested formally that such a situation is ill-thought out but nothing has been done.

      I expected people to pick-up on the basic inaccuracy of the claims from the Economist magazine. Perhaps the lack of them demonstrates how low its stock has fallen.

      • In fact, Shaun, there was a disagreement on the target rate at the time of the 1993 renewal agreement between Governor Crow and the incoming Liberal Minister of Finance Paul Martin, as recounted in Mr. Crow’s memoirs. Governor Crow wanted to lower the target rate to 1.5% and did not put his name forward for a second term when Mr. Martin refused to agree to it. The language about the 2% target being an intermediate target on the path to price stability in the original 1991 agreement was removed from the 1993 renewal agreement. That agreement and the appointment of Governor Crow’s successor, Gordon Thiessen, were announced at the same time.
        I had the honour of meeting Michael Wilson, arguably Canada’s greatest Finance Minister ever, when the Ottawa Economics Association presented him its Award of Distinction on December 2. The Minister who had introduced inflation targeting to the Bank of Canada in February 1991, he still remembered as if it were yesterday, the path for target rates, from 3% to 2½% to 2%, that he had signed off on in the original agreement.
        Mr. Wilson told me that it would be a mistake to attach too much importance to the disagreement between Governor Crow and Finance Minister Martin over the target rate. He said that Mr. Martin simply didn’t trust Mr. Crow to implement policies that Mr. Martin would be comfortable with. The only thing that could have given Mr. Crow a second term was the re-election of a Progressive Conservative government.
        Be that as it may, the Liberal government was lucky that it came into office in November 1993, less than three months before the expiry of Governor Crow’s seven-year term. A dispute between the Minister of Finance and the Governor of the Bank of Canada over the target rate halfway through the Governor’s mandate could get much uglier, especially if the Governor were more given to theatrics than John Crow was.

  2. Hi Shaun

    I’ve always thought that the German economy, being much more geared towards exports, would have a much more “undervalued” Euro than the rest. The efforts they made in the “noughties” to get their own costs in line have also paid off. What I’m in effect saying is that the ER of the Euro is continually dragged down by the laggards (which now appear to include France) and, under these circumstances the Germans will effectively have the advantage of this, which they wouldn’t have if they had the DM.

    I do not see how you can ever get economic convergence unless you have a full economic and political union and, even in that case (vide the USA) you would still get regional variations in growth due to underlying differences in productivity exacerbated by less than perfect labour mobility. The Eurocrats have put the cart before the horse but of course people did not want the horse (political union) in the first place.

    This is clearly not just an economic issue as we have the rise of populist movements who express the profound dissatisfaction of large segments of their native populations at the way things are going; in my view this can only get uglier.

    • Hi Bob J and welcome to my part of the blogosphere

      I have discussed this subject on past blogs and I proposed this view. Back then it was widely considered that the other nations had got one over on Germany via the monetary policy measures and bailouts (SMP,EFSM,EFSF,ESM…). However the undercut was that Germany had accepted this in return for a more competitive exchange range. Having reformed its economy as you say it was ready to take advantage of it.

      I can now add to that a view that the exchange-rate gains are now much larger. The problems and travails of Denmark and Switzerland show us that a new DM would shoot upwards like a helium balloon.

  3. How can the Ezeurocrats can be happy with these figures?? 0,9%???? Are they insane?
    This won’t end well . Statistically revise up and down, these figures are horrible. Austerity messiah please come to help us! We have endure so long, too long we worshiped you and still you haven’t brought us any good! Time for some human sacrifices? Official ones that is?
    And the Spanrecovery is just mirrored in the some strong deflation who is actually speeding up the Podemos movement more faster than Rajoy can count how many papers Yaroufakis has published.
    Looks every day closer, the moment of Podemosity

  4. Hi Shaun
    From 2000-2014, the annual GDP growth in France has exceeded that of Germany in 8 years ( out of 15 years) , the latest being 2013. Not exactly a sign of great divergence. Short-term trends have more to do with political ‘initiatives’ rather than underlying factors which are more or less the same in all northern European states. Clearly the EZ will be constantly under strain until either political union exists or its dissolved, but ‘picking’ stats to ‘prove’ the strain exists doesn’t really add anything new.
    As a previous resonse has said, there would be exactly the same strains between States in the US without political union. Regions of the UK vary considerably more than large areas of France and Germany.

    • HI JW,
      Even in the USA political union does not automatically guarantee convergence – Detroit may be bankrupt; nobody really wants to live in North Dakota (for example). Political union just makes divergence more manageable – as Bob J alludes to. On the other hand I just can’t see the United States of Europe being as successful as the United States of America – even if the populace voted for it.

      • Hi Eric
        Yes, just more manageable, differences will always exist.
        There are a lot of myths about the differences between countries. For instance its often a stick held to beat France about their unionised workforce and how they hold the country to ransom. Yet right now, unobserved by most MSM in the UK etc, a large element of the retail/wholesale distribution in the States is being held to ransom by just over 1000 dockworkers in LA. They think they are underpaid at a current avarage package of over $250k each. They also use extortion and physical threats to keep their position of ‘power’. Its estimated that a week’s strike would lop 0.3% off the 2015 US GDP growth rate.
        C’est la vie!

    • Hi JW

      One of the issues in this situation is the Question of Sport one “What happens next?”. I was responded to on twitter with a chart comparing Germany and France but with the years 2016-20 included. I replied that you could forecast anything! Where we are is a period since 2010 where France has hit a weak spot but as you highlight the boot has been on the other foot in the past.

      If you have not seen it FT Aplphaville has unearthed some old figures and an old debate- for example my argument that Italy could reverse its unification on economic grounds- but nonetheless is a reminder.

      • Hi Shaun
        Thanks for the link, hadn’t seen it.
        As the text says if you were to adjust for ‘social charges’ , its likely the French and west German ‘colours’ would be more or less the same. We have remarked previously that taking Switzerland as a ‘centre point’ , the regions around it ( including northen Italy) have much in common , economically.
        The SNP have obviously been taking a close look at the Basques!

  5. Crikey I had forgotten about poor old “Dim Wim” as he was known in Holland.

    I wonder what history will have to say about him when the bones of the Euro Project are eventually picked over. He always felt the French were responsible for evicting him from his post three years early and it’s possible to speculate if this drove him to his early grave, Still, at his leaving dinner he warned EZ governments against breaking their “contract with the people” and that it would be a “disaster for Europe” if the Stability Pact falls apart. “If they let the Pact go, they’ll be the losers in the end because the people won’t accept it”.

    You couldn’t make it up.

    Incidentally I will be in Holland the back end of next week and will report back to the blog on my economic findings!

    • Hi Andy

      I look forwards to your update. You reminded me about the Netherlands so I took a look at its statistics site. The first entry is a clear Valentines Day link but gives us a clear line into another element of what is called the Rotterdam Effect.

      “9.1 million roses exported on a daily basis
      A considerable part of the roses imported from other countries are sold through the Aalsmeer flower auction and re-exported to countries elsewhere in Europe. In total, the Netherlands exported more than 3.3 billion roses worth over 1 billion euros, i.e. 9.1 million roses on a daily basis.”

      Good news? Er not for Dutch rose growers.

      “The number of businesses engaged in rose cultivation was reduced from 765 in 2000 to 142 in 2014, a decrease by 29 relative to 2013. The rose cultivation area was also reduced substantially from 932 hectares in 2000 to 311 hectares in 2014, a reduction by 73 hectares from 2013. ”

      As for Wim Duisenberg I suspect that history will not be especially kind.

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