Tuesday 19 June 2018

Dan O'Brien: Amid euro-area revival, one fear is Italy falling into a Greek-style tragedy

For two decades Italy has been bringing up the rear when it comes to growth in the big continental economies. Stock photo: Deposit
For two decades Italy has been bringing up the rear when it comes to growth in the big continental economies. Stock photo: Deposit
Dan O'Brien

Dan O'Brien

Business and consumer confidence across Europe is almost uniformly high. In some cases it is at record levels. Last week's first estimate of euro-area GDP for the final quarter, and the year as a whole, confirmed the durability of the upswing.

The continental core is finally showing some of the dynamism that parts of the periphery - including Ireland and the Baltics, for instance - have been showing for some time.

The surge in optimism and positivity about the Continent's economy began early last year when almost all indicators started to perk up. That was unexpected.

Europe's recovery since the euro crisis of 2010-13 had been lacklustre. As of the start of last year there was no particular reason for forecasters to expect 2017 to bring about change. But change came, and, although finding an explanation is not easy, stronger economic growth has been universally welcomed.

The euro-area economy expanded by 2.5pc last year. That was the fastest since 2007 and the third-fastest annual rate of increase this century. All 19 countries in the currency bloc grew. Unemployment fell in 18 countries over the course of the year. There is a lot of momentum all across the single currency area, something that augurs very well for 2018.

As the big four economies - France, Germany, Italy and Spain - account for 80pc of the euro-area economy, the focus here will be mostly on them.

But before looking at how they are doing it, it is worth highlighting a few issues from the smaller 15 countries that have the euro as legal tender.

The former communist countries that are in the single currency grew more rapidly than the longer-established democracies to the west. The three Baltics states, along with Slovakia and Slovenia, are on course for full-year expansions of 3-5pc last year (full-year figures have yet to be published for many national economies).

Their non-euro neighbours are also doing well. As such, the income gap between east and western Europe is narrowing, although it is still large in most cases despite almost 30 years having elapsed since the Berlin Wall came down.

There was also good news on the north/south divide last year. The three southern countries that were bailed out during the crisis - Greece, Portugal and Cyprus - are all likely to register their best years since the crisis started a decade ago, with the latter two growing at a decent clip. Although Greek growth was weak last year, it is the first year in which the economy has expanded since 2014 when the then nascent recovery was killed off by the political brinkmanship of a new and inexperienced government.

Returning to the big four, let's start with the star performer. That was, yet again, Spain. The Iberian economy expanded by 3.1pc last year, the third consecutive year in which it is exceeded the 3pc threshold.

The continued strong performance of the Spanish economy came despite the enormous political shock of events in Catalonia towards the end of the year, which appears to have had only a limited impact on the national economy.

Germany continue to grow strongly, if less spectacularly, than Spain.

Last week, it reported full-year GDP growth of 2.2pc. Last year was the first year in half a decade that the German economy grew by more than 2pc.

French president Emmanuel Macron was born lucky. The French economy grew by around 1pc a year between 2014 and 2016. He became president in the middle of last year and growth almost doubled. Even better was the composition of the expansion. It was driven by accelerating investment and export growth.

For two decades Italy has been bringing up the rear when it comes to growth in the big continental economies. That ignominious record continued last year. But with growth accelerating to a creditable, if relatively sluggish, 1.5pc, the big European economy that needs growth most urgently got it last year.

So while the European economy is doing well, and there is every reason to believe that it will continue to do well in the short term (barring a shock), the damage of the past decade will take a long time to fix. This is particularly true of the public finances.

The politics of the developed world is very much predicated on economic growth. Without it, the entire system comes under immense strain. Since the 1970s most governments across the western world have spent more than they have taken in taxes.

Running perpetual deficit is perfectly feasible when economies expand, but in the absence of growth, the deficit and debt dynamics change quickly, as was all too clear during Ireland's crash and for many other countries during the euro crisis.

Across the single currency area as a whole the deficit between revenue and spending continued to narrow last year.

In the second and third quarters it was less than 1pc of GDP, the first time that has happened in two consecutive quarters since 2007.

Shrinking deficits and stronger growth combined to push public debt in the euro area down. As of September it stood at 88pc of GDP. But that is down a mere four percentage points below its peak five years ago. This shows just how hard it will be to bring it to levels that would give some fiscal leeway when the next downturn takes place.

What's even more concerning is the trend in one country: Italy. As the chart shows, it has made no progress at all in bringing down its public debt.

At 134pc of GDP, it is at levels recorded in Greece when that country plunged into crisis. The failure to reduce the debt is all the more concerning given that debt-servicing costs have been historically low thanks to multi-trillion purchases of government bonds by the European Central Bank. With an end to those purchases now clearly on the horizon, debt servicing costs will rise over the coming years.

Without an extended period of solid economic growth, it is all too easy to see Italy facing a Greek-style crisis.

And as was made too clear during the euro crisis, the single currency is only as strong as its weakest link. That has not fundamentally changed.

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