Abstract
This work illustrates the nature of the core/periphery imbalances and anaemic long-run growth in the Euro area and discusses the problems associated with addressing them through expansionary fiscal policies in the core regions and greater domestic expenditures in unreformed peripheral areas. As competitiveness imbalances across regions have widened, both fiscal measures may backfire, and a more nuanced policy mix is in fact needed to reverse the unequal spatial distribution of high-value-added activities and resource misallocation. Addressing the factors behind such imbalances is key for the survival of the Euro area because their size and persistence clash with the tendency towards an equalization of workers’ aspirations: this aspirations/resources mismatch is in fact fuelling discontent and populist animosity against the EU institutions and the core countries.
The authors would like to thank Roberto Tamborini and the participants in the conference “Highs and Lows of European Integration” at the University of Trento and in the EconPol launching conference in Brussels for useful comments.
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Notes
- 1.
However, if Spain, Malta and Greece are excluded, this association becomes somewhat weaker. This may be due to measurement problems in the output gap, which is in fact unobservable. Potential GDP can also be overestimated and the gap underestimated, as forcefully argued by the Italian authorities with respect to the European Commission’s estimates.
- 2.
Even senior economists at the IMF have, in recent years, openly discussed some patent failures of the neoliberal approach/agenda, among which are the alleged expansionary effects of fiscal consolidations, which never materialized (Ostry et al. 2016). More in general, Blanchard and Leigh (2013) raised doubts concerning the effectiveness of fiscal consolidation plans in serious recessions and stimulated further work on the relationship between fiscal consolidation and growth.
- 3.
As much as this strategy was not effective in the EA, it did seem to work in some Baltic states and in other countries outside the EU. The different outcomes depend on the size and degree of openness of the countries, as well as on the exchange rate regimes in place. Even in the successful cases, however, the adjustment channels at work appear to be complicated and controversial, as shown by Blanchard et al. (2013), and previously discussed by Dani Rodrik in “What I learned in Latvia” on his weblog http://rodrik.typepad.com (2012) and Paul Krugman “Latvian competitiveness”, http://krugman.blogs.nytimes.com (2012).
- 4.
Paulus et al. (2017) show that consolidation measures not only negatively affected aggregate household income and consumption but, due to salaries and benefit cuts, also generated undesirable distributional effects due to the penalization of financially constrained, poor households. On the contrary, Attinasi et al. (2017) find limited negative externalities on the vulnerable countries of widespread fiscal consolidation because of the beneficial effects materializing in the financial realm and of the endogenous expansionary reaction of the ECB monetary policy, in line with the channels identified by Corsetti et al. (2013).
- 5.
- 6.
This view, however, is contested by other scholars. First, it is not clear whether or not the pre-crisis investment level in the EU was abnormally high (Gros 2014). Second, the declining growth rates of the working age population and total factor productivity may not be compatible with a higher rate of investment, given the high capital-output ratio in the Eurozone. Finally, it appears that waste and inefficiency reduce the extent to which public investments are translated into actual improvements of public assets in various countries (see IMF 2014).
- 7.
No consensus has yet been reached in the debate on the size of domestic fiscal multipliers, which can vary depending on the type of the fiscal shock, on the contingent state of the economy (with larger multipliers in recessions) and on its structural features (Blanchard and Leigh 2013; Ilzetzki et al. 2013).
- 8.
Using model simulations, IMF (2013) finds that a 2-year increase in spending in Germany (for about 1% of German GDP) boosts real GDP in the rest of the EA by 0.2%. According to In’t Veld (2013), an increase in government investment by 1% of GDP in Germany and other EA core countries could raise real GDP in the remaining EA countries by 0.2–0.3%. ECB (2014), however, finds values for the same stimulus varying between 0.03% in France to 0.06% in the small EA member states. The two-step methodology adopted by Ivanova and Weber (2011), where only the impact of fiscally induced changes in domestic output on net exports of trading partners is considered, suggests that a reduced consolidation effort by Germany alone would have had a limited positive impact on the European periphery. Studies adopting the GVAR methodology, such as Hebous and Zimmermann (2013), are not conclusive either, because they provide evidence of a highly differentiated impact of foreign fiscal shocks across the EU countries. Different are the results from the adoption of the local projections methodology used, for instance, by Auerbach and Gorodnichenko (2013) and Goujard (2017), which tend to produce greater estimates of the spillover effects; Goujard (2017), for instance, argues that a fiscal contraction in Germany by 1% of GDP leads to a reduction of output growth by 0.23% points for a typical OECD country and to an even greater contraction in EA countries, whereas Poghosyan (2017) finds that 1% of GDP fiscal consolidation in Germany has large contractionary impacts in both the short and the medium term, respectively, 0.16% and 0.24% of Euro-area GDP (of which only 0.07% and 0.08% are associated with spillovers).
- 9.
Moreover, both were hit by two common shocks that turned out to have highly asymmetric effects within the Eurozone: (1) the accession of China and Eastern Europe in the global market and (2) the introduction of the euro, with the rapid convergence of nominal interest rates.
- 10.
Focusing on the trial length of civil disputes to proxy for the quality of contract enforcement in Italy, Accetturo et al. (2015) find that firms located in courts with higher trial length have a lower probability of supplying customized intermediate inputs to foreign firms.
- 11.
Since the 1970s, nominal wages have been negotiated at the national level and extended to the whole of Italy, in spite of the remarkable differences in productivity, prices and unemployment rates between the regions in the center-north and the south. As a result, salaries and wages in the formal economy of South Italy’s labour market have responded little to local labour-market conditions. The Mezzogiorno was already part of a malfunctioning currency union long before its accession to the Eurozone, and it instantiates the kind of situation that the core countries would like to avoid reproducing within the Eurozone.
- 12.
Capello and Caragliu (2016) develop quantitative foresights for the future development of the North-South divide in Italy under two alternative scenarios in terms of policies to address the crisis: a place-based competitiveness scenario and a social cohesion one. They conclude that the former approach can lead to the highest aggregate growth rates and to the lowest increase in regional disparities.
- 13.
By proxying non-price competitiveness with cumulative investments, Algieri (2014) shows that the long-term export performance of EA peripheral countries is affected not only by worldwide real income and price competitiveness but also significantly by non-price competitiveness. In particular, in Italy the erosion of non-price competitiveness has been the most important determinant of its declining export performance since the mid-1990s (Algieri 2015).
- 14.
Cuadrado-Roura et al. (2016) put forward a more nuanced account whereby growing regions in Poland, Slovakia and Bulgaria have compensated lagging regions in Romania, Hungary and Latvia, thereby limiting but not halting the catching-up process. That said, they concur that in the EU-15, considerable regional divergence has taken place after the crisis, widening regional disparities.
- 15.
Similarly, Crescenzi et al. (2016) provide evidence of a negative association between the regional resistance to the crisis in the EU and the extent to which the regional environment is innovation-prone.
- 16.
Low-growth NUTS2 regions are among the less developed and transition regions that did not converge to the EU average between 2000 and 2013 in countries with a GDP per capita in PPS below the EU average in 2013. Such regions are in Greece (11), Italy (8), Spain (5) and Portugal (4). Low-income regions include those with a GDP per capita in PPS below 50% of the EU average in 2013, i.e. those in Bulgaria (5), Hungary (4), Poland (5) and Romania (5) are included for low income.
- 17.
Besides measurement problems, we acknowledge that it is indeed controversial to maintain that regions, like firms, compete in a zero-sum game. While this interpretation of regional competitiveness has been harshly criticized in the literature (Krugman 1996; Kitson et al. 2004), regions do strive to attract high-value-added activities. Based on this very idea is the RCI proposed by Dijkstra et al. (2011), and we interpret the index in these terms.
- 18.
The former find that, despite having lost their original advantages, historical portage sites in the USA continue to enjoy a relative importance in terms of industrial activity. The latter, by focusing on the protection that rugged terrain provided to African areas during the slave trade, shows that geography can have important effects on income through its interaction with historical events.
- 19.
Exploiting regional variation in Italy, Lasagni et al. (2015) show that better local institutions help firms to become more productive.
- 20.
The concentration of competitive firms in an area generates static and dynamic agglomeration externalities, forming a self-enforcing circle. See Fracasso and Vittucci Marzetti (2017) and the references therein.
- 21.
Giordano and Zollino (2016) also show that the varying extent to which offshored intermediate inputs have been incorporated in the domestic production functions across countries has determined the divergent developments in unit labour costs and producer price indices across EU member states, thereby complicating the assessment of price competitiveness indicators. Timmer et al. (2013) provide evidence that between 1995 and 2008 the ability of countries to retain final manufacture goods-related GCV jobs was correlated with real wage moderation.
- 22.
Bourles et al. (2013) show that market power in upstream industries reduces incentives to improve efficiency and curbs productivity in downstream industries.
- 23.
Notably, García-Santana et al. (2016) find that heterogeneity in financial dependence, capital structure intensity, skill intensity, tradability and innovative content is unrelated to changes in allocative efficiency. Similarly, regional differences in wage growth or house price growth appear uncorrelated with the increase in distortions.
- 24.
Cœuré (2017) acknowledges that other factors may temporarily contribute to capital misallocation and poor productivity growth: “The crisis, for example, might have restricted access to external finance for financially constrained firms, which sometimes are those with high productivity growth potential. […] Furthermore, banks typically require loan collateral in the form of tangible assets, such as real estate, machines, etc. This may encourage firms reliant on bank funding to invest more in tangible assets than they would otherwise do. At the same time, research shows that having a greater share of intangible assets is related to a greater ability to create and absorb new technology. But, financial frictions are likely to have been only a temporary factor”.
- 25.
Malgouyres (2017) finds that import competition from China negatively affected local employment. First, there is evidence of a strong effect of direct competition in the manufacturing sector. In particular, job destruction is concentrated in the low- and medium-skilled occupations. Wages appear to be uniformly negatively affected in the manufacturing sector, whereas wages in the non-tradable sector are affected only in the middle of the distribution (contributing to greater wage inequality and polarization).
- 26.
It is worth noting that these phenomena have spurred a literature investigating the effect of financial developments on the cyclical and structural component of the business cycle (see Borio et al. 2017).
- 27.
These considerations go hand in hand with the negative effects exerted on the public finances by regional decentralization in Italy (and in France). Some have argued that the low stock of civic capital in the Mezzogiorno, and therefore the clientelistic and often corrupt habits of the local élites, led in many cases to the wastage of public funds.
- 28.
A special Eurobarometer survey conducted by the European Parliament in 2016 shows that the share of young people feeling that in their country young people have been marginalized by the economic crisis (IT 78, ES 79, EL 93, PR 86, IE 68, CY 81) is much larger than those thinking that they are compelled to leave the country in order to improve their circumstances (IT 26, ES 25, EL 43, PR 41, IE 15, CY 51).
- 29.
We would like to thank Roberto Tamborini for encouraging us to explore our hypothesis in greater detail.
- 30.
Using the data from the European Social Survey (6-2012, ed. 2.3), it can be shown that the share of those with a household income lower than the national median value is, in almost every region, larger than the share of people placing themselves in the lower half of the social scale. A similar finding holds for the share of the population receiving an income in the first decile of the distribution and the share of population perceiving itself at the bottom of the social scale. This pattern is particularly marked in the regions of the periphery where the correlation between these variables is extremely low. These results are consistent with the idea that most people perceive themselves as occupying a position in society that is not in line with their relative income, and this misperception may be associated with a widespread inclination to hold unrealistically ambitious aspirations.
- 31.
Economic-related issues are only some of the various determinants of the success of populist parties in Europe. Caiani and Graziano (2017) show that the emergence of populist parties is better explained by political determinants, such as institutional mistrust. Inglehart and Norris (2016) find evidence in favor of the cultural backlash thesis, according to which in European countries there has been a reaction by predominant sectors of the population against “progressive” values, with the emergence of anti-immigrant attitudes, support for authoritarian values and the like.
- 32.
It has been observed by some that Germany benefited from an external value of the euro that did not fully reflect the differential in economic fundamentals between Germany and the non-EA countries, due to the fact that the external value of the Euro depends also on the fundamentals in all the other EA countries.
- 33.
For a discussion of the political economy of national debates, we refer to Bonatti and Fracasso (2013) and Bonatti and Fracasso (2017) for Germany (or to Matthijs and McNamara 2015 for an alternative take), Featherstone (2015) and Afonso et al. (2015) for Greece and Portugal, and Fernández-Albertos and Kuo (2016) for Spain. It is worth noting that the evolution of poverty and inequality across different age-, job- and nationality-based groups has been as extremely diversified across and within EU countries, resulting from the interaction of different underlying structural problems, a differentiated impact of the crisis and of austerity measures varying in accordance with domestic political economy forces (Walter 2016).
- 34.
- 35.
Put another way, whether structural disparities and imbalances are excessive or not depends also on the system’s capacity to withstand them, which is in turn is determined by institutional and cultural factors.
- 36.
On the two pillars (rules and coordination) that historically characterize economic governance in the EMU, we refer to Pisani-Ferry (2006).
- 37.
The creation of the ESM can, to a certain extent, be seen as an ad hoc exceptional alternative to the creation of a stable Union budget to alleviate serious financial problems at the country- and union-level.
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Bonatti, L., Fracasso, A. (2019). Addressing the Core-Periphery Imbalances in Europe: Resource Misallocation and Expansionary Fiscal Policies. In: Antoniolli, L., Bonatti, L., Ruzza, C. (eds) Highs and Lows of European Integration. Springer, Cham. https://doi.org/10.1007/978-3-319-93626-0_10
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