Growing Pains: Europe's Dilemma
IMF Blog, October 21, 2011
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- Authors: innovation.
- Published: October 21, 2011
Divergent per capita GDP growth in Europe
- Growth rates in the past decade ranged from close to zero in Italy and Portugal to more than 4 percent in the best performers.
- Some countries grew much slower or faster than expected given their income level (convergence only part of the story): Italy and Portugal grew slower than expected; the Slovak Republic and Sweden grew faster.
Role of convergence and other factors
- Convergence: poorer countries can grow faster by importing technology; richer countries at the technology frontier can only grow faster through innovation.
- Convergence does not fully explain differences in growth performance across European countries.
Integration into the global economy
- Better-performing countries are much more integrated into the world economy than poor performers.
- Strong performers experienced high and increasing levels of trade (both exports and imports); many poor performers have lower and stagnating levels.
- Examples:
- In Austria, Germany, the Netherlands, and Sweden, the share of export and import in GDP rose by about 15 percent to more than 20 percent between 1995 and 2010.
- The Czech and Slovak Republics, and to a lesser extent Poland, saw similar increases.
- Greece, Italy, Portugal, and Spain experienced stagnation in export-to-GDP and import-to-GDP ratios over those years.
How to recover from "euro sclerosis"
- Historical precedent: late 1970s and early 1980s episodes of “euro sclerosis” (high unemployment and low growth) show policy change can reverse decline.
- Case studies: the Netherlands and Sweden in the 1980s and 1990s
- Both countries undertook sweeping reforms after prolonged malaise and crisis.
- Conditions before reform: income per capita falling relative to Germany for about a decade; deteriorating public finances; growing fiscal deficits.
- Country-specific constraints:
- Netherlands: rising unemployment driven by high real wage costs.
- Sweden: poor-performing traditional industries, the banking crisis in the early 1990s, and stifling taxes.
- Policy responses:
- Netherlands: wage agreement between employers and unions as the centerpiece to restore employment; additional tax and benefit reforms to create jobs and encourage labor force participation; reduced regulation to allow new companies and industries to flourish.
- Sweden: fiscal consolidation, tax reform, clean up of the banking sector, overhaul of the wage bargaining system; reduced regulation to foster new companies and industries.
- Outcomes: reforms spanned more than a decade and took time to yield full benefits; per capita income in both the Netherlands and Sweden is now significantly higher than even that of Germany.
Lessons and policy recommendations for current poor performers
- Reforms work—but they take time.
- It takes time to implement reforms, time before their impact becomes visible (initial deterioration possible), and time before full benefits accumulate.
- Address both macroeconomic imbalances and barriers to growth.
- If deficits and debt are not brought under control, growth is unlikely to pick up.
- Correcting macroeconomic imbalances alone, without removing growth barriers, will not result in sustained high growth.
- Reform priorities evolve over time.
- As initial bottlenecks are removed, new constraints become binding and require sequential policy attention.
Source: Growing Pains: Europe's Dilemma (October 21, 2011).
